What to Do With the Stimulus Check

Many of you likely have received your stimulus check. I explained the qualifications for receiving these tax rebates—technically tax credits—in last week’s Investor Update. (I also answered several questions in the comments section.) If you qualify and have not received it, you can check the status of the stimulus check and fix any errors on the IRS’ website.

This week, I’m going to build on last week’s commentary by talking about what to do with the stimulus check if you—or someone you know—are among the many already having received or expecting to receive the tax rebate.

I’m bringing this topic up because it ties into a broader project we’re working on at AAII: helping you to create a comprehensive plan that guides your investing decisions. A personal investment policy statement serves as a much-needed guide when the financial markets are experiencing high levels of volatility, as has been the case since late February. It also helps you make decisions about what to do when “sky money” lands in your lap (a reference to money falling from the sky).

Among the basic premises underlying such a plan is the answer to a key question: When do you need the cash? If you view the stimulus check from a modified form of Maslow’s Hierarchy of Needs, the decision about what to do with it becomes clearer. (The same exercise can also be applied to your entire portfolio to determine what your financial tolerance for risk is.) Let’s walk through the broad stages you or someone you know might be in.

Little or No Emergency Savings—Many recipients of the stimulus check will, unfortunately, need to spend the money on basic needs such as housing, food, medicine, health insurance, etc. Those caught in this tough financial situation have no choice but to spend the money.

Others matching this profile may not need the money immediately but also may not have much in the way of emergency savings. A 2019 Federal Reserve study found that four in 10 adults could not cover a $400 emergency expense with savings. And while the average AAII member is affluent, many of you may know someone who isn’t. Encouraging them to use the stimulus check to start building (or add to insufficient) emergency savings is a good step. (It’s also timely since April is Financial Literacy Month.)

Likely Will Need the Money Within Five Years—If there is a known or expected need for the cash within the next five years, putting the stimulus check into a savings account, money market fund or something similar also makes sense. While stock prices currently remain well below February’s record highs, timing risk remains high for such a short period of time. Even if the stimulus check won’t cover the full expense (e.g., you anticipate replacing your car or making an expensive repair to your house), keeping it in cash or cash equivalents (e.g., money market funds) can reduce the amount you will need to withdraw from your investments.

Likely Will Need the Money Within Five to 10 Years—This time period creates some options. The odds of losing money over a 10-year period by holding a diversified portfolio of stocks are historically low, but a bad sequence of returns is still a risk. A balanced allocation like 60% stocks and 40% bonds can provide a cushion. An alternative would be a barbell approach, which combines stocks with very conservative assets. If avoiding any loss of capital is your top priority, you could build a ladder of short- and intermediate-term bonds and certificates of deposit (CDs). By doing so, you would incur the risk of inflation eroding the value of what you have saved.

Keep in mind that with this time frame you’re likely looking at spending more than you received from the stimulus check and will have to make similar decisions with the other dollars you’re planning on allocating toward the same goal. Allocating the stimulus check to a traditional or Roth IRA also makes sense here for those who have earned income and would not otherwise max out their contributions.

Won’t Need for at Least 10 Years—If you won’t need the money for an extended period of time, then a strong argument for putting it all in stocks can be made. Your lengthy time horizon allows you to financially withstand short-term volatility in order to achieve long-term growth in wealth. Additionally, inflation becomes a much greater risk than unfavorable sequences of return. Traditional and Roth IRA contributions make sense here too.

There is, of course, another option beyond those mentioned: giving the tax rebate away to charity. The CARES Act incentivizes charitable giving during the 2020 calendar year with a $300 deduction available regardless of whether the standard deduction is taken, plus the removal of the 60% cap on charitable deductions for those who itemize. So long as your taxable income equals or exceeds the donation (and the stimulus is not taxable income), you could effectively claim a deduction on donations equal to part of or even all of the stimulus check. Consider it a reward for being charitable.