Improving our personal finances is mostly a gradual process. The primary means for a better balance sheet tend to take time. These include:
- Increasing Income: You may need to acquire certain skills or experience for a higher salary.
- Cutting Expenses/Debt: Reducing costs beyond the obvious may be difficult. With static cash flow, putting a dent in principal debt balances is difficult.
- Investing and Saving: A lack of disposable income makes saving money or investing difficult.
Tax refunds are a chance to improve your personal finances in ways not otherwise possible. With the average U.S. tax refund nearing $3000, you can pay down debt, start investing or create an emergency fund.
Unfortunately, there’s disconnect between how taxpayers intend to use refunds and the actual result. The emotional high of a lump sum payment causes impulse purchases. Holiday shopping and other consumer spending is fueled by anticipating tax refunds.
So, what are specific options to use tax refunds in more productive ways?
Here are some choices to consider:
Pay Down Principal on Credit Cards:
High interest rate cards make it difficult to pay down principal balances. As a result, many cash strapped borrowers simply pay the minimums on their loans or revolving debt. The result is much higher interest expense and long term debt.
Lump sum money from a tax refund applies more payment to principal, which results in faster payoff and interest savings.
Home equity lines of credit and unsecured personal loans are other examples to consider.
Best Practice: You should focus tax refunds on the most expensive debt, rather than a piecemeal approach. Start with your highest interest rate and balance card. Apply the entire amount you intend to use for this card or loan. If money is left over, move on to the next expensive card.
Debt reduction has a high return on investment. Paying off a 15% credit card translates to an equal return on your money.
A tax refund provides the capital to purchase shares in stocks, mutual funds or other investments. This is particularly helpful to smaller investors with limited disposal income. While a tax refund seems small to start your portfolio, the power of compounding makes this a wise choice.
What is the power of compounding? Simply put, the principle says a dollar is more valuable today than at a later date. Inflation is an economic concept that considers this concept.
Starting now with a smaller amount yields greater results than starting later with larger sums. Investor Elliott Broidy and mutual fund managers consider compounding when making portfolio decisions.
Individual investors can also use compounding when using tax refunds to start investing. Your tax refund check is an important step to investing, which is simply getting started.
Improve or Get Insurance Coverage:
Adequate insurance coverage is an investment in your financial security. Homeowners should review their policies for gaps in flood, fire and liability protection.
Renter’s insurance is also within reach for most tax refunds. Many landlords require renter’s insurance for mutual protection against theft and other property crimes.
Best Practice: Reviewing your various policies may identify overlaps for fast savings. For instance, your AAA membership and auto insurance may have duplicate roadside assistance or auto glass coverage.
How Will You Allocate This Year’s Refund?
Tax refunds are a fast and convenient way to improve your finances. You also gain insight on better money management by using refunds in beneficial ways.