April 8, 2021
While the debate of whether receiving a large tax refund just means that you paid too much in taxes throughout the year still goes on, there’s no denying that a large cash inflow gets us excited about all the potential ways we could put that money to use. If you get a tax refund you were not expecting, the “extra” money can provide a breather from day-to-day expenses and provide you a boost towards your long-term financial goals. Here are some ideas on how you can use your tax refund in a way that keeps building wealth:
Have you carried a credit card balance for as long as you can remember? Now’s the time to pay it off and tackle that debt. Start with debts with the highest interest rates; eliminating these will save you the most money in the long run.
If you are stressed about student loans and other low-interest debt (or are perhaps behind on payments), use the tax refund to pay these off. While the interest rate may be low, late-payment charges are totally unnecessary and can add up to a large chunk over multiple months. It may also be worthwhile to call your loan provider and ask if they can waive some fees if you make a large payment (they may be more receptive to your request if they know a payment is coming in soon).
If you have a short term goal that you’ve been saving for, such as moving to a new city, topping up your emergency fund, or buying a house, use part of your tax refund to further your goals.
When it comes to saving up for a home, use your refund to increase your down payment to avoid costly private mortgage insurance payments and also to reduce the overall amount of your mortgage.
One of the best ways to use your tax refund to build wealth is to invest that money. By doing so, you let that money, and the money from future tax refunds, and the returns you get from these refunds, grow on a compounding basis for years.
For example, if you receive a $3,000 refund, invest it and over the next 10 years earn a 6% average annualized return, you’ll have more than $5,000 in that investment account. That’s $2,000 for doing pretty much nothing.
It gets even better if you commit to investing your $3,000 refund in each of those 10 years. After letting compounding and earnings do their thing, you’ll have more than $40,000 in your investment account. And if you stay disciplined and continue to invest your $3,000 refund every year for two decades — for a total of $60,000 invested — after a 6% average annual return, you’re looking at around $120,000, or double the total amount invested.
Building wealth by investing in the stock market is possible and not limited to just the rich. Most families who save consistently, and over time, can get millions simply by having discipline and a diverse portfolio.
Let’s be honest – a couple thousand dollars wouldn’t go far in traditional real estate. Fortunately, that’s no longer the only option. You can invest in REITs (Real Estate Investment Trusts) through most investment platforms. Real estate platforms like Diversyfund also let you invest money in real estate that can help you grow your net worth over time. The added advantage of these real estate investment assets is that they give you access to stable cash flows and capital gains without the hassle and stress of managing rental property. They also require a much smaller capital inflow ($500-$1,000) at the onset, compared to buying a property.
If your job offers to match any of the money you invest in an employee retirement plan, invest enough to qualify for the matching funds and take the free money. If you have additional income, invest in an Individual Retirement Account (IRA) to save even more for retirement.
Guess what the biggest income-producing asset you have access to is….it’s you! You can use the tax refund to increase the value of your human capital. There are multiple ways to do this, all of which play to your specific skills and talents. Your expertise, talent, experience, work ethic and reputation can all be boosted through an investment, whether that be additional training, tuition, a work-related conference or membership in a professional organization. It could even be something that you’ve always wanted to try, like a photography or cooking class. Maybe you’ve just never been able to convince yourself to get Invisalign. The extra funds from a tax return can help you make your life and career better.
A tax refund is also a great opportunity to support your community, perhaps by donating to a cause you care deeply about. It not only benefits those in need but also gives you a great feeling (the importance of which can’t be overstated). If you regularly volunteer (or would like to start), combining a monetary gift to your work can be a great strategy – plus, it can be a potential donation deduction for next year’s taxes.