What should I do with my annual bonus: SIP, lump sum or loan prepayment?

The bonus has arrived. For a few days it feels like real money: big enough to make a difference, small enough that it could vanish into a new phone, a family trip and a few things nobody remembers buying.

Most people already know they "should do something sensible" with it. The confusion is between three sensible-sounding choices: start or top up SIPs, invest a lump sum, or prepay a loan. The good news is that you do not have to pick one. You need an order.

Why does the order matter more than the product?

Each use of a bonus has a different kind of return:

• Paying off a credit card balance saves interest at up to about 3.75 percent a month, roughly 45 percent a year. That saving is certain.
• Prepaying a home loan saves interest at your loan rate, typically in single digits for large banks right now. Also certain.
• Investing in equity funds may earn more over long periods, but with ups and downs and no guarantee.

A certain high saving beats an uncertain return. So the bonus should flow from the most expensive problem down to the long-term opportunity, in that sequence.

Step 1: Clear costly debt first

If you have a rolled-over credit card balance, a personal loan, or a consumer-durable EMI on a high rate, start here. A ₹1 lakh card balance left unpaid at an assumed 3.5 percent a month grows by about ₹51,000 in a year. No investment can reliably beat that.

Personal loans typically cost in double digits. Prepaying or closing them frees up a monthly EMI that you can then direct into savings. Our guide to clearing credit card debt fast walks through the details.

Step 2: Fill the emergency fund and plan next year's big costs

Next, check whether you have six to twelve months of essential expenses set aside. If not, the bonus is the easiest way to build it in one go.

Then set aside money for the big costs you already know are coming in the next twelve months: insurance premiums, school fees, a planned family function. If they are not funded now, they will arrive as "surprises" and go on the credit card, undoing Step 1.

Step 3: Prepay the home loan or invest?

This is the real decision, and only the money left after Steps 1 and 2 belongs here.

Many families split the remaining amount between the two. Our deeper comparison of prepaying a home loan versus investing in SIPs goes into this, and if you do prepay, read whether to reduce the EMI or the tenure.

On floating-rate home loans, lenders cannot charge a prepayment penalty to individual borrowers.

Illustration: A home loan of ₹40 lakh at an assumed 8.5 percent has 15 years left, with an EMI of about ₹39,390. Prepaying ₹2 lakh of bonus money and keeping the EMI the same would shorten the loan by about 17 months and save roughly ₹4.7 lakh in interest over the remaining life of the loan. That saving does not depend on markets. (Illustrative arithmetic on an assumed rate; your loan's terms will differ.)

Lump sum, SIP or STP: how should the investing part go in?

If some of the bonus goes to long-term equity investing, the question becomes how to put it in.

• Lump sum in one day: all of it is invested at once, so its result depends heavily on that day's market level.
• STP (systematic transfer plan): park the amount in a liquid fund and move a fixed sum into an equity fund every week or month over, say, six to twelve months. This spreads the entry.
• Raising your monthly SIP: this commits your future monthly salary, not the bonus. Only raise the SIP to a level your salary can carry even in a year with no bonus.

For money meant for a goal within about five years, equity is usually a smaller part of the mix. Which specific funds to use should be checked against your situation through a SEBI-registered adviser.

What might a bonus plan look like in practice?

Illustration: A senior manager receives a gross bonus of ₹4 lakh. After tax at the 30 percent slab plus cess, about ₹2,75,200 reaches his account. He has a ₹70,000 credit card balance, an emergency fund that is ₹75,000 short of nine months' expenses, and ₹30,000 of insurance premiums due in March. The rest goes half to his home loan and half into equity funds through a six-month STP. (Illustrative numbers, not a real client.)

Next year, with no card balance and a full emergency fund, Steps 1 to 3 will take much less, and far more of the bonus can go to Steps 4 and 5. That is how a sequence compounds: each year's bonus does more than the last.

What should you avoid?

• Deciding after the money lands. Write the plan before the bonus is credited.
• Buying a product because someone called the week your bonus arrived. Bonus season is also selling season.
• Investing while carrying card debt. It is effectively investing borrowed money at a very high rate.
• Locking all of it away. A small, planned amount for the family is part of a good plan, not a failure of one.

Putting the bonus through this order, alongside your EMIs and goals, is exactly what we map in a first conversation.