For many individuals, an income tax refund may be one of the biggest single amounts of cash received for the entire year. Don’t be tempted to spend your refund frivolously. There are many ways you can use your refund to further your long-term financial objectives. You can choose to reduce your current debt, invest in the stock market, make improvements to your home, or invest in a retirement plan.
Let’s suppose you expect to receive a $5,000 tax refund. The best return on your investment might be to pay off current debts that have high interest rates. For example, if you have a credit card carrying a balance at 15% interest, reducing that balance is equivalent to earning a 15% return on your money. Your payment of $5,000 will save you $750 in interest expense over the next 12 months. A 15% return is exceptional when equated to most other investments. If you maintain a $5,000 balance on the credit card and make only the minimum monthly payment, you may pay double that amount in interest, depending on your interest rate.
A second option might be to reduce the principal balance on your home mortgage. A $5,000 reduction in a 4% thirty-year loan will save you $11,000 in interest expense over the life of the loan.
Consider putting the cash into your retirement plan. Only one in five Americans can retire with sufficient resources to live independently. If you invest $5,000 at a 6% compounding rate, you will have an additional $28,000 in thirty years. Your retirement fund could total almost $450,000 if you were to invest $5,000 each year for thirty years at a 6% compounding return. How often do you hear people say that they retired with too much money?