Inside: It can be fun to spend a tax refund like it is found money. See if these bad ideas are part of your plans and discover smarter alternatives.
Did you know the average tax refund is about $3,000? What would you do (or, will you do) with that money?
Setting aside a little bit for fun such as a dinner and a movie is perfectly reasonable. We’d all love to pad our entertainment funds a bit.
How about the rest of the money?
Every year you’ll likely hear your friends and coworkers talking about plans to spend their newly found wealth. You might even get a chuckle out of some of the plans.
While many people will find responsible things to do with their tax refund, others…not so much.
Here are some of the worst ways to spend the windfall along with smart ways to spend your tax refund.
Bad idea: Put money in low-interest savings
Saving your refund in a savings account seems like a good idea, especially if you need to build up your emergency fund or are saving up for a purchase in the near future.
But what kind of interest are you earning on that money? Many banks only offer about 0.01% annual percentage yield on savings accounts. That means after a year, that $3000 will turn into a whopping $3000.30. Wow. A whole 30 cents?!
Better idea: High-interest savings
If you do want to save your money, then look into high(er)-interest savings accounts. Many online banks offer this and won’t charge a fee. A quick search yielded several online banks offering rates of about 2%.
Hmmm, 0.01% or 2%? It’s a no-brainer.
With a $3000 balance, you won’t get rich, but at the end of a year you’ll have an extra $60, which is a whole lot better than 30 cents. And as your account grows, that compound interest will continue to boost your savings.
Bad idea: Splurge on an expensive vacation while in debt
A windfall of money seems like a great chance to take a bit of rest and relaxation. How about a Caribbean cruise, a short tour of Europe, or maybe even visit the Taj Mahal?
Those all sound great, and if you have your emergency fund built, high-interest debt paid off and are saving for retirement, then have fun!
On the other hand, if you are paying off credit cards or other high-interest debt, then using the money on an expensive vacation will compound the problem. You’ll likely add charges for lodging and food and souvenirs.
Better: pay down high-interest debt
If you put your refund towards paying off that high-interest debt, you likely get a better return on your money than even investing. With that 14%, or even 24% interest you are being charged on your credit card, you’ll get an immediate return on your money of the same amount if you pay off the debt.
Lacking an emergency fund? Get that started first before tackling the debt. Without at least a basic $1000 emergency fund, it is likely the next “emergency” will go on the credit card.
Bad idea: Fun time at the casino
Double or nothing, baby! Why not increase leverage your money and win even more money at the casino? You or your friend has a no-fail system and you’ll be smiling all the way to the bank.
There is a small chance you’ll get lucky. Odds favor the casino taking your money, though.
Better: Invest your money
If you already have your emergency fund established and you want to save for retirement, then depositing the funds into a retirement account is a great choice. When investing in a good, low-cost total stock market index fund, it is likely you’ll average between 6-7% return over the long term (some years will be better than others).
Once again, you’ll get great bang for your buck by either paying down debt or investing. Or, how about investing in yourself?
Take a class and learn new skills that you can leverage to get a raise or a better job. Betting on yourself seems a smarter way to go than playing roulette.
Why are refunds special?
For some reason, people treat money from a tax refund differently than what they get in their paycheck. It feels like a bonus, or found money when in reality it is something you’ve worked for.
It seems special because, wow, here is a lump sum of money after scraping by for the past year. This is great! Or, that’s what we think.
If you get a refund or manipulate your withholding to purposely get a larger refund, then treat it as money you’ve earned like any other paycheck. Chances are, it should have been part of your paycheck, anyhow. Put the money to work for you and you’ll find stress levels go down as your debt gets paid off and your future becomes more secure.
What are you doing with your tax refund?