If you found yourself getting a tax refund this year, how do you plan on using it?
Even though getting a refund really just means that you overpaid your taxes the previous year, we know the excitement that comes from seeing that extra money once a year.
Something else that comes from tax refunds is a lot of inner turmoil. You know it’d be smart to use that extra money to put yourself into a better place financially. But when things like new clothes, fancy restaurants, or even tropical vacations start to enter your head… well sometimes there’s no turning back.
We want to encourage you to stay strong this year! Using your refund smartly, rather than for something temporarily gratifying, is going to benefit you greater in the long run and is really your best shot for setting up the kind of life where you can regularly buy yourself those fun things in your future.
One small, smart decision now can change your life later.
So, keeping those goals in mind, here are 3 smart ways to spend your tax refund this year. Consider it a challenge and pick the one you think will help you out the most.
1. Build an Emergency Fund
If you don’t already have an emergency fund, you might want to choose this option. Everyone should have an emergency fund, because of course, everyone is susceptible to emergencies!
Things like unforeseen job loss, emergency medical or vet bills, and sudden repairs for things like a furnace or vehicle can really hit you hard if you aren’t prepared. Taking out loans to cover those costs can be avoided if you have an emergency fund.
Many financial experts will recommend saving at least 3-6 months’ worth of living expenses. If you can manage that, then great! But for a lot of people that might be a lofty goal and your tax refund may not cover it. We believe that having any amount, no matter how small, is better than none. It’s something you can always add to in the future if you find yourself with a little extra money available.
Consider using a high-yield savings account dedicated only to your emergency fund. DON’T put the money in your everyday checking or savings account or you’ll be staring at temptation every day.
The important thing to remember is that this is for emergencies only. That means something you absolutely need, not want. Evaluate your situation carefully before withdrawing from this account.
2. Pay Off Debt
Debt from credit cards, personal or student loans, etc. can be a heavy monthly burden and when you have multiple lines of credit, it can really add up. One of the smartest things you can do with your tax refund is to use it to pay off debt. This one step can lead to you paying off multiple debts sooner than if you just meet the minimum payment requirements each month.
Consider using Dave Ramsey’s Debt Snowball Method. You can find stories all over the internet of people who became debt-free using this method. The basics of the method are to scrounge up as much extra money as you can to pay off your smallest debt first (this is where you’d use your tax refund) while paying the minimum amount due on other debts. After your smallest debt is paid in full, take the money you paid monthly on that debt, along with any extra money you can afford, and put it towards your next smallest debt. The goal is to continue building on your payments, one debt at a time, until you have them all paid off. It’s a simple method and the bottom line is it works.
And once all those monthly debt payments are out of your life, think of what you could do with that extra cash! Saving for your future, growing that emergency fund, those fancy restaurants and vacations you wanted but held out on? Now you can have them.
At some point in your life, people will likely begin pushing you to invest in something for your financial future. This might be stocks, real estate, an IRA, or a 401(k) and we agree, investing is crucial to having a comfortable life one day.
Investing is putting money into financial products to increase its value and ultimately, receive even more money than you originally invested. Taking a large chunk of money like your tax refund and investing it is a great way to make passive income for your future.
Investing can be very complex though. Even deciding what to invest in can feel overwhelming. There are companies out there that can manage everything for you, simplifying the process. NerdWallet recently published a list of some of the best online stockbrokers for beginners, which could be a good place to start.
If you’re considering investing in your retirement fund instead, check out our tips on that here.
Experts don’t always agree on whether your primary focus should be on paying off debt or saving for your future. There could be several factors to consider here including the interest rate on your debt vs the interest rate you will earn through investing. Either option is smart and can help you be better off. Consider talking to a financial adviser who can take all of your factors into account to create a plan for you.