ASK KIM
Put Your Bonus to Work
by Kimberly Lankford

I am just about to receive year-end bonus at work and am wondering whether I should use it to make an extra mortgage payment or invest the money instead.

Congratulations on your bonus. Receiving extra money like that is one of the rare opportunities to make a big difference in your finances without having to make sacrifices. And you're asking about it at a great time -- if you decide what to do with the money before you get it, you'll be more likely to put it to good use rather than just spend it on holiday gifts.

Before deciding whether to invest the money or make an extra mortgage payment, first make sure your other financial bases are covered.

Most important: pay off high-interest credit card debt. As soon as you stop paying high interest charges each month, you'll have more money to devote to other goals, which will have a huge ripple effect on the rest of your finances.

Next, beef up your emergency fund. You should keep three to six months' worth of living expenses in a safe and liquid account, so you won't have to go into debt or raid long-term savings for unexpected bills. Search for the best money-market account at our Yields & Rates page.

After you've covered those bases, then you can consider other investments:

• Boost contributions to your 401(k). If you haven't maxed out your 2004 contributions, this is a perfect time to add the money to your account. You'll avoid paying taxes on the extra cash (since you can invest it pretax into your account) and may get an employer match.
  
  
• Increase your IRA contribution. Add to your account if you haven't yet invested the maximum $3,000 for 2004 ($3,500 if you're 50 or older). If you've already hit that limit, use the money for your 2005 IRA contribution after New Year's Day (the maximum contribution limit rises to $4,000 next year; $4,500 if you're 50 or older).

If you still have money left over, then consider paying down your mortgage or investing the money in a taxable account.

First of all, ask yourself how long you plan to live in the house. If you plan to move up, or out, before it is completely paid off, adding to your principal doesn't make much sense. You are simply locking your money up until you sell.

But if you plan to pay off the home and live there after retirement, speeding up the payoff could be a big help to your post-retirement bottom line, and not having to make a mortgage payment could mean greater peace of mind.

Just make sure the rest of your investments are diversified -- you don't want to wrap up too much of your money in your house. Although we expect real estate will continue to appreciate across the U.S. generally, there could be localized exceptions.

For better diversification, consider devoting part of your bonus to the mortgage and then investing the rest.