The Skinny:
A bonus should be treated as the cherry on top not the sundae. Use the funds to square away your near-term financial needs and then use the remainder to invest in assets or ventures that compound your money and knowledge much more effectively than traditional investments.
Viewing Bonus Money the Right Way
Perhaps the most exciting time of the year for finance employees is bonus season. Typically there is a consistent window each year (e.g. the first half of December) when companies will sit you down and give you a performance review, your bonus number for the year, and any title or salary escalations. It is always a bit nerve-wracking but if your firm likes you and you are a good worker, the news is usually good.
Real estate investing is well-paid but compensation is often bonus heavy. While base salaries are often very respectable, bonuses can sometimes be 50% or more of total comp, which is a very material split. These are discretionary as well so they are variable and harder to forecast. This inherent trait and its namesake should tell you exactly how to view these juicy funds. They are a bonus. They are gravy. They are extra, and you should therefore not factor it into your life as a given at all. Yet many workers, both young and old, make the mistake of living their life under the assumption that the bonus is guaranteed.
The reason this is dangerous is two-fold. First, real estate is a cyclical industry and is prone to shocks. We have seen this time and time again with various historical recessions and more recently with value collapses resulting from low-rate fueled price run-ups as well as massive secular shifts in the way companies operate. Do you think many funds who were solely focused on office received any decent bonuses in 2021/2022? Nope.
Second, treating your bonus as a given will set you back when it comes to living and saving. The base / bonus structure gives you an easy path to live below your means and to spend your bonus money in much more judicious ways. This is not a feel-good personal finance post about a rigorous savings plan but if you can live off of your base salary while putting away 20%+ of that to savings, the bonus truly becomes more valuable to you when it hits your bank account. Many finance professionals run at a near net-loss despite making a ton of money as they fall victim to lifestyle creep and materialistic spending.
The Role of the Bonus
In my opinion, a bonus should only serve one of two purposes: to either (i) grow your savings and knowledge base faster by investing in valuable ventures with above-average returns or (ii) help you purchase something truly meaningful to you or your family that was previously out of reach.
A well-known investing mantra is to “never spend the principal, only the interest” and that is essentially what I am getting at with purpose #1. The bonus is something that you should be able to live without, it should not be essential to your day-to-day life or base savings plan. Since it is not essential and not something you need, I believe this is a logical reason to invest in something higher up on the risk/return spectrum. A fundamental goal of anyone’s life should be to build up plenty of savings to become financially free and to provide for your current or future family. While I am a dedicated Boglehead with a large portion of my money with Vanguard, index funds are not the fastest way to reach this goal. While you should be putting your base salary savings in traditional investments, the bonus money is where you should try and seek outsized returns. The power of compounding is incredible. In your base savings plan, $100k earning 10% (rough proxy for historical S+P return) would be worth ~$260k in 10 years but $100k in your bonus savings plan earning 15% would be worth ~$404k (+55% difference).
While purpose #1 is all about investing, purpose #2 focuses on spending. Using bonus money to purchase something meaningful is a totally legitimate use of the funds. The most straightforward example of this would be to buy your first home for yourself or your family. Ignoring the debates about whether primary homes are the best financial decision, the fact is that owning a house is an incredibly rewarding life event that brings a level of joy that simply cannot be quantified. Shelter is a primal need and having your own place, especially in American culture, provides incredible satisfaction. Other “acceptable” uses would be to take a loved one on a proper trip or pursue some other long-deferred adventure. Many trips are expensive but provide a return in the form of worldliness and culture that also cannot be quantified in dollars and cents. What you should absolutely not spend your bonus on is stupid things like bottle service, $20k luxury watches, or other frivolous things. Even if you feel like you deserve to “treat yourself”, you are only doing yourself a disservice and older you will laugh at younger you, I promise. There are always better things to do with your money than to buy stupid things just to impress people.
My Favorite Way to Invest Bonus Money
After you run your bonus through a savings waterfall, there should be a net amount remaining that is total “gravy” to you, which I believe should be used for higher octane investing. My #1 recommendation is to buy real estate for yourself. Depending on the amount leftover each year, this will likely be a single-family rental or a small multifamily property.
Why buy real estate? Well not to sound like the thousands of real estate or personal finance blogs out there, but it is objectively the most effective way to build wealth. The hard and empirical data is undeniable. It is simply an outstanding mechanism for generating high returns and improving your net worth. But given this site is tuned more towards existing financial or real estate professionals as opposed to newbies, buying real estate offers another major benefit. It makes you a lot better at your day job.
Even if you buy a small $200k house that only puts $100 in your pocket each month, there is something vastly different in your learning experience when you are doing everything for yourself and with your own money. You naturally take it a lot more seriously and will put in more effort to know the ins and outs of every single thing that is going on. You cannot zone out on anything and expect someone else to catch all the details because there is no one else. For example, if you work on the investments team at a large real estate fund, there are countless controls and double checks along the way to make sure an investment is done correctly. When it is your own investment, it is just you and your roster of third-parties. It is up to you and you alone to make sure it is done properly.
Once you get your first solo property or two under your belt, you will bring your newfound self-reliance back to your day job. You will think about things more fully and from the perspective of the investor. Although a single-family home and a $200mm office building are worlds apart, they are both pieces of real estate and the investment and risk management processes are mostly parallel. Your experiences inside and outside of the workplace are symbiotic to each other and will supercharge your knowledge and capabilities in both worlds. It is ultimately the combination of the two that will give you the confidence to perhaps go out on your own full time. A bonus is the healthy and genuine pride that comes out of successfully running your own deals, it gives you a sort of “swagger” that will help you navigate future endeavors.
The only major prerequisite is that you must be ready and comfortable to undertake such an investment. Real estate investing is a heck of a lot more complicated than simply clicking “buy” on VTI in your brokerage account. You are buying a physical piece of land with income-producing improvements on it and will be responsible for doing proper underwriting, due diligence, risk assessment, and of course asset and property management. There is a lot more work and sweat equity in these investments than passive ones. Do not jump in until you are ready and until then, use the prospect of buying your first investment property as motivation to get real sharp on the full investment lifecycle and get comfortable with anything you do not understand.
Once you dive in, there is no going back. You will have discovered a healthy addiction and will want to buy more properties and snowball them into bigger ones. This is the way. If you could use your annual bonus to successful buy a property each year, it will be pretty hard not to end up in a great place both mentally and financially.
Some Other Good Ways to Invest Bonus Money
As mentioned above, the bucket of capital that remains from the bonus allocation process is intended to be used for investments that provide a higher return. If direct real estate investing is not for you (or if it’s just not the right time), here are some other good ways to try and seek outsized returns. Remember, your goal is to do better than traditional investments and try and earn returns of say 15%+ while compounding your money and your knowledge.
Invest with Clever Friends – one of the biggest mistakes I ever made was not investing with a good friend of mine when he asked me to. He is one of the sharpest guys I know, even if he is a little kooky (though I find kookiness and success seem to be very correlated actually). He had a well articulated idea about buying underperforming car washes WAY before it was mainstream in the private equity world and he offered me a slot as one of the LPs for a reasonable check size. I said no because I did not have an LLC / entity to invest with at the time (a silly BS reason) but the real reason was I was just intimidated by the prospect of not investing in something I had no direct control over. I had complete faith and trust in my friend and his business plan, but I was still scared. Last time I checked, those investments 3x’d and were spewing out annual cash returns of 25%+. Whoops! Scared money don’t make money, lesson learned.
If you surround yourself with sharp friends as I hope most of you do, there will be opportunities, especially as you approach career maturity (say late 20’s and 30’s), to invest some of your more “risk-on” savings in ventures with these sharp friends. Many will be highly experienced and have a command of their career field. If you have trust and confidence in your friends to deliver, and if their idea is in their realm of expertise, it may payoff big time to invest with them. I was at a lunch recently and heard the story of an industry peer who was asked by a friend to invest $100k in his burgeoning clothing business a while back. He did not know much about clothing but he enjoyed the product and trusted his friend. The company is called Vuori and now I see it EVERYWHERE. I could not get an exact ROI, but I would estimate 5-10x. Obviously this is just one example (my other friend who invested in his buddy’s alcoholic kombucha venture did not do so well!) but the point is that these are the times when you should step up and put your money where your mouth is with people you trust. It could pay off in a big way and supercharge your returns. A big bonus is that they will likely treat you the same way if and when you call to ask if they want to invest in your real estate venture. If they trust you, they will invest even if they do not know what a cap rate is. That is how it works after a certain level because they too want to improve their returns with people they believe in.
Invest with a “Hive” – this is similar to investing in your smart friends, except you are doing it WITH them. I found out that both myself and a former co-worker were doing this our own friends and I think it is such a great idea. Essentially you assemble a group of 5-10 of sharp friends who would be down to invest together. In an ideal world it would be a fairly diversified group with some in finance, tech, marketing, trades, and consulting for example. Bonus points if someone is a lawyer. You then create an entity that you would all contribute to, create some by-laws to govern the investment processes and procedures, and go out and find things to invest in together. The investment ideas could be something as simple as a particular stock or something more exotic like an off-the-grid AirBNB in Joshua Tree. The idea usually comes from one person and is then hashed out and vetted by the rest. You may find that you do not agree on much and may not invest in anything together, and that is totally fine! The best part about this arrangement is that you are continuously sharing ideas with a group of smart people, which in turn makes you a better thinker as you all gain from the power of osmosis, discussion, and banter. It will also make you more intellectually curious and motivated. While others may be eating cheesy poofs and trying to hit a new personal best kill / death ratio in COD, your hive will be trying to find killer returns in all sorts of nooks and crannies in the world. There is actually a platform now called TribeVest that makes the process very easy. I have not used it personally but it looks awesome.
Stock Picking – let me preface this by saying that I do not personally believe anyone can outperform index funds in the long-run (plus there are reams of data to back this up). However, I highly recommend dedicating some of your money to securities that you will pick yourself for the non-financial benefits. Mainly that it should force you to become interested and fluent in the general markets and future trends. This is both a creative and an analytical exercise. You should study up on what you think the next big things are in the world, learn how to analyze companies, and develop your own system for picking securities and gauging their performance. Just like real estate, stock picking is all about identifying value wherever it can be found and since the skillsets are complementary, it all flows back into your ever-growing toolbox.
You may find that you have a knack for it and can consistently crush index funds. Peter Lynch, one of my idols, certainly believes the average person can do better than professional investment managers. However he was from a different era and today’s world is much more efficient with the endless information streams and high-powered algorithms. Real estate’s greatest differentiator remains its informational inefficiency, which allows you to capitalize on mispricings. While it is very difficult to find those in the public markets, they do exist. If you can spot them there, you can definitely spot them in real estate and make a killing in both.
Invest in Other “Alts” – the late David Swensen was an investment pioneer who created the “Yale Model”, an investment philosophy that allocated more capital towards alternative investments (e.g. real estate, private equity, hedge funds) in search of more diversification and higher returns. He eschewed boring liquid investments like bonds and sought out more illiquid investments that provided higher returns. Since this bonus bucket of capital should be money you do not need anytime soon, it is an ideal time to seek out higher returns with more unique asset classes that likely have less liquidity in exchange.
If you want to invest in real estate but are not yet ready or able to own directly, there are countless platforms out there right now that can help you gain exposure (that are true direct ownership, NOT REITS). My personal favorite is Fundrise because you can curate your investments based on your goals with simple and understandable options. Their CEO is brilliant and their website / app are very well done. Also, unlike its competitors, you do not have to be accredited (income and net worth thresholds) and can invest right away with little money. If you are accredited and are comfortable reviewing individual deals, there are options like Crowdstreet, Cadre, RealtyMogul, and Yieldstreet.
Other real assets that are considered part of a healthy portfolio are commodities such as gold and oil because they have a low correlation to traditional markets and are a proven inflation hedge. These will NOT provide you with any dazzling outsized returns but are good to have for many other reasons. For example, I keep a small amount of physical gold in a safe (in case the world goes to complete turmoil) and invest in crude oil (so that if the prices at the pump go up, I can at least feel good I am getting some of that back). But again, these are more for diversification and the goal of this bucket is really for outsized returns so I would view these as almost a separate matter.
I cannot directly recommend other alts as I have not invested in them myself, but there are quite a few options to choose from nowadays that could be worth exploring. At worst they will offer some diversification (and perhaps some conversation starters) and at best they may offer some real potential upside. Wine and art are now much more investable via modern platforms such as Masterworks and Vinovest. Obviously cryptocurrency is another major option, although I am not personally a “believer” at this time. The last one I will mention is P2P Lending via platforms such as LendingClub. I honestly like the concept but just have not found myself compelled to invest in them when there are more options I am comfortable with out there.
Summary:
A bonus is money that should not be viewed as guaranteed and is not a source for your living expenses. Far too many people squander their bonus on lifestyle upgrades or other frivolous things that torpedo their balance sheet in a misguided pursuit of status. Save a majority of your bonus and use it for the things that really matter in life such as family and financial security. After shoring up your near-term financial needs and contributing to traditional savings accounts, use the remainder on investments or projects that will better compound your money and knowledge. Direct real estate is the most powerful investment and is the best place to put bonus money to work. If this is not for you then target other non-traditional investments such as alts and ventures alongside successful peers. A bonus is a gift and provides you a great way to be disciplined and to get a leg up on 99% of the world when it comes to financial strength. Do not squander it.
