If you have some extra cash on hand and you're thinking that spending it on a large-screen TV or a visit to some blackjack tables is probably not the smartest thing to do with it, you're right. It's true that a TV set can provide myriad hours of entertainment, but many of us have more pressing needs and better ways to spend extra money. Below are three good ideas.
Pay off debt
Are you carrying any high-interest rate debt? If so, it's quite imperative to pay that off as soon as possible. Carrying hefty credit card debt is the opposite of investing: You might hope to get ahead by an annual average of 10% in the stock market, but if you're paying 25% annually on credit card debt, what you owe can grow much faster than your stock investments. Being deep in debt can also wreck havoc in your life in other ways, such as making it hard to get a mortgage to buy a home.
High-interest rate debt can spiral out of control rather quickly and can be very hard to pay off. According to the folks at NerdWallet, the average household with credit card debt owes around $16,000 -- and pays an average of $1,292 in interest alone each year. If you carry a balance of $16,000 with a 25% annual interest rate and a minimum payment of 4%, it will take you 19 years to pay off that debt, and in the process, you'll pay a total of more than $33,000. Whether you owe $2,000 or $25,000, applying $1,000 to reducing your debt can make a big difference in your financial health. If your interest rate is 25%, you can avoid paying $250 in interest!
Image source: Getty Images.
Start an emergency fund
Do you have an emergency fund? Don't think of it as something optional -- you may not expect to lose your job anytime soon, but lots of people who are laid off didn't see it coming, either. A costly medical issue can derail you financially, too.
Consider that according to a 2016 survey by the folks at Bankrate, a whopping 66 million Americans have no money saved for an emergency expense. It's not just a problem for the poor: About 23% of those earning $75,000 or more had less than three months' worth of living expenses saved. If you're still not concerned, note that per a 2015 Pew Charitable Trusts report, more than 60% of Americans experienced a several-thousand-dollar financial shock in the previous year. Would you be able to handle that?
If you don't have an emergency fund, or at least an emergency plan, then you might end up wiping out a critical retirement account or charging many thousands of dollars on a credit card, leading to costly debt. Worse, you might lose your home. The best way to protect yourself is to have an emergency fund available -- enough to cover around six months' worth of expenses, give or take a few months. How should you determine exactly how much to sock away? Well, focus on the monthly expenses you have to pay in order to stay in your home and survive. Thus, sock away three to six months' worth of rent or mortgage payments, along with the costs of utilities, food, transportation, and anything else you really can't do without. Include loan repayments, too, such as for any credit card debt or car loans, etc.
Emergency fund money shouldn't be in the stock market or other places where it's vulnerable to volatility. It needs to be in more stable places such as money market accounts or bank accounts -- where it probably won't grow in value by much, but it won't shrink much, either. If you have $1,000 on hand, it could serve you well if it's parked in an emergency fund. (Remember, too, that even if you never need to tap the fund, it's still serving you well by keeping you protected from financial disasters.)
Image source: Getty Images.
Invest in stocks
Finally, a great thing to do with $1,000 if you're not carrying high-interest rate debt and have a flush emergency fund is to invest it in stocks. It would have to be long-term money, of course, that you don't expect to need within five, if not 10 years. You can become a savvy investor by doing a lot of reading about investing and then carefully selecting stocks in which to invest, after researching them diligently. That can take a lot of time, and you'll inevitably make mistakes along the way, but it can be well worth it. Below, for example, are the long-term returns of some well-known stocks. (They're just examples of what stocks can do for you -- none is guaranteed to perform similarly in the coming years. Some may do better -- or worse.)
10-Year Avg. Annual Return
20-Year Avg. Annual Return
Data source: Yahoo! Finance.
There's a simpler path, though, and it's a smart and profitable one: investing in index funds. Index funds are mutual funds or exchange-traded funds (ETFs) that are based on various indexes of stocks or other securities. Index funds based on much of the stock market, for example, have a long history of outperforming stock mutual funds managed by Wall Street pros. According to Standard & Poor's, as of the end of June 2016, fully 87% of all domestic stock mutual funds underperformed the S&P 1500 Composite Index over the past 10 years. And 85% of large-cap stock funds underperformed the S&P 500.
A handy low-cost broad-market index fund is the SPDR S&P 500 ETF, which distributes your assets across 80% of the U.S. stock market. The Vanguard Total Stock Market ETF or the Vanguard Total World Stock ETF will, respectively, have you invested in the entire U.S. market, or just about all of the world's stock market. There are index funds for bonds and real estate, too, such as the VanguardTotal Bond Market Index Fund and the Vanguard REIT Index Fund.
If you have some extra money on hand -- be it $500, $1,000, or $5,000 -- you'd do well to put it to good use, strengthening your financial health. You can do so by paying down debt, funding an emergency fund, or investing long-term dollars in the stock market.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's Board of Directors. LinkedIn is owned by Microsoft. Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns shares of Boeing, Costco Wholesale, Microsoft, and Starbucks. The Motley Fool owns shares of and recommends Costco Wholesale, PepsiCo, and Starbucks. The Motley Fool recommends Chevron. The Motley Fool has a disclosure policy.