April 23, 2018
Every year, about 8 in 10 Americans who file their taxes receive tax refunds. But a much smaller percentage of us put this money to good use and improve our personal finances. Today, I want to go over some ways our listeners can do just that!
If you do not have one already, create an emergency fund. I know I say this time and again, but many American households do not have enough money saved up to cover unexpected expenses. According to Bankrate's latest financial security index survey, 34 percent of American households experienced a major unexpected expense over the past year. However, only 39 percent of survey respondents said they would be able to cover a $1,000 setback using their savings.
Unexpected expenses will impact most households at some point, and they can be devastating if we are not prepared. So, if you haven’t already started an emergency fund, use your refund to do just that! Your goal should be 3 months of living expenses, but start off by building your fund up to cover one month.
The next thing you want to do is pay down debt. When doing this, you want to prioritize some kinds of debt over others. If you are behind on payments for secured debt, meaning an asset is tied to it, such as your home or your car, get current on this debt first. After this, start working on unsecured debt. If you’re deciding between paying down credit cards, student loans and personal loans, the easiest way to choose is to look at the interest rates for each category. Then use your tax refund to reduce the highest-interest debt - most likely credit cards – so it does not continue to grow. But there is one situation where you may want to put debt on the backburner, Tom.
Your retirement savings. One of the best things you can do with your tax refund is drop it into your 401k or retirement account, because of the power of compound interest. If someone was to deposit $1,000 and if they maintained a 4.5% annual return rate, then, over 25 years, they would triple their money. That is a great use of a refund to build one’s retirement. And if you are able to cover your credit card bills, and if your employer matches your retirement account contributions that you are not taking full advantage of, putting your refund to work in your 401k could receive a 100 percent ROI instantly when you get your employer match. If we consider the same $1,000 refund at the same return rate, but it gets matched, then, over the same 25-year period it could grow to over $6,000. That is a huge opportunity if one forgoes the instant gratification of spending their return now and focuses on their long-term goals.
The information on this page is provided for educational purposes only and is not tax, legal, financial planning or investment advice. Neither the information nor any opinion expressed in this section constitutes an offer to buy or sell any securities or advisory products. The information provided is general and is not information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. You should not regard this information as a substitute for the exercise of your own judgment. Investing involves risk.