How to Invest Your Tax Refund Wisely

How to Invest Your Tax Refund Wisely

Invest Your Tax Refund

You’ve received your tax refund, and now you don’t know what to do with it. Don’t worry; regardless of the amount, it’s great that you’re considering making that money work for you instead of letting it sit in your bank account. In this guide, I’ll show you various worthwhile options for investing your tax refund wisely in the US.

What’s your Financial Status?

What’s your current financial situation like? Before jumping into any investment choices, reviewing your financial goals and how much risk you’re comfortable with is important. Are you nearing retirement, planning for your children’s education, or saving up for a down payment? 

When you take the time to understand your objectives, you’ll be better equipped to select the most suitable investment strategy.

How to Allocate Your Tax Refund

Several options come to mind when deciding where to allocate your tax refund. Below, I’ve listed the most popular and worthwhile choices:

Tackle High-Interest Debt

Use your tax refund to pay down the balance if you have an interest or annual percentage rate (APR) of 6% or higher. 

It’s easy to want to throw money at starting a business or investing in volatile assets like cryptocurrency. Still, these moves can be risky, especially when dealing with significant debt. That’s why paying off high-interest items such as credit card debt, car loans, mortgage payments, student loans, and other potentially damning debts can significantly reduce interest expenses.

Build Your Emergency Fund

Emergency savings can help you handle an unexpected bill without getting into debt. A 2024 Bankrate survey found that almost 44% of American adults can’t afford a $1,000 emergency expense. If you haven’t already, try using some (or all) of your tax refund to kick-start or boost your emergency fund to cover at least 6 months of living expenses.

Simply putting $5k into a High-Interest Savings Account (HISA) can help you handle unexpected costs without debt. Again, instead of investing immediately, prioritise saving until you have a solid emergency fund and maybe a sizable down payment for a house.

Contribute to Retirement Savings

Use your tax refund to boost your retirement savings. You could contribute to a workplace retirement plan like a 401(k) or 403(b), especially if your employer offers a matching contribution. Alternatively, you could contribute to a traditional Roth IRA for long-term financial growth.

Set Aside Funds for Future Taxes

If you’re self-employed or your income varies yearly, consider saving a portion of your tax refund to cover future tax bills. This can help you avoid costly penalties for underpayment of taxes.

Open a Tax-Free Savings Account (TFSA) or a Guaranteed Investment Certificate (GIC)

GICs offer a guaranteed interest rate in exchange for depositing your money into a financial institution for a fixed period. GICs are often called term deposits because your funds are locked in for a specific period, ranging from 30 days for short-term GICs to 10 years for long-term GICs.

On the other hand, a TFSA can hold cash and/or various investments like GIC’s, segregated funds, specific stocks, bonds, or mutual funds The cash in a TFSA earns interest just like a regular savings account, but the interest is tax-free.

To understand more about mutual funds, read our complete beginner guide to mutual funds.

ETFs

ETFs offer diversification, which means your money is spread across various assets like stocks, bonds, or commodities. This diversification helps reduce the risk associated with investing in individual securities. Additionally, ETFs typically have lower fees than mutual funds.

ETFs also offer exposure to specific sectors or themes. For example, if you’re interested in investing in emerging technologies like blockchain and cryptocurrencies, ETFs that track indexes related to these sectors are available. This includes crypto ETFs like Bitcoin ETFs, which provide exposure to the cryptocurrency market without the need to purchase and store digital assets directly.

Grow Your Income

The best investment you can make is in yourself. Think about using your funds to find ways to boost how much you earn. Maybe invest in certifications or further education to open up new opportunities in your career. You could also use the money for classes or workshops that help you better manage your money, like budgeting, investing, and handling debt.

What’s the Difference Between a Refund and a Return? And Which Is Better for You?

The main difference between a tax refund and a tax return is that a tax return is a document you file with the government to report your income and deductions. On the other hand, a tax refund is the money you get back from the government if you’ve overpaid your taxes throughout the year.

Now, which is better for you depends on your financial situation. 

Having a large tax refund might seem like a nice bonus, but it means you’ve been giving the government an interest-free loan with your money throughout the year. So, getting a big refund might be a sign that you’re having too much tax withheld from your paycheck. In this case, adjusting your withholding so you receive more money in your paychecks throughout the year could be better for you financially. That way, you can invest or save that extra money instead of waiting for a lump sum refund at tax time.

On the other hand, if you struggle to save or invest money throughout the year and tend to spend it instead, having a larger tax refund might be beneficial for you. It could serve as a forced savings mechanism, allowing you to receive a sizable sum of money once a year that you can then use to pay off debt, cover expenses, or invest in your future.

Tips for Making the Most of  Your Tax Refunds

Seek Professional Guidance

Consider consulting with a financial advisor who can offer personalized advice tailored to your financial situation and goals.

Start Small

If you’re new to investing, begin with modest amounts and gradually increase your investments as you become more confident and experienced.

Stay Committed

Stick to your investment strategy and avoid making hasty decisions based on market fluctuations or emotions.

Assess Your Investment Timeline

Determine when you may need access to the invested funds. For short-term goals, prioritize investments offering liquidity and stability.

Minimize Fees

Be mindful of investment fees, which can reduce your returns over time. Look for low-cost options like index funds or ETFs to maximize your profits.

Avoid Over-Withholding

Overwithholding happens when your employer takes more money from your paycheck for taxes than needed. This means you get a tax refund when you file your taxes because you paid more than you owe. Prevent over-withholding by your employer, which can result in a sizable tax refund. Instead, invest that money throughout the year to avoid providing the government with an interest-free loan.

What’s the Difference Between a Refund and a Return? And Which Is Better for an Individual?

The main difference between a tax refund and a tax return is that a tax return is the document you file with the government to report your income and deductions, while a tax refund is the money you get back from the government if you’ve overpaid your taxes throughout the year.

Now, as for which is better for you as an individual, it depends on your financial situation and goals. 

Having a large tax refund might seem like a nice bonus, but it means you’ve been giving the government an interest-free loan with your money throughout the year. So, if you’re getting a big refund, it might be a sign that you’re having too much tax withheld from your paycheck. In this case, adjusting your withholding so you receive more money in your paychecks throughout the year could be better for you financially. That way, you can invest or save that extra money instead of waiting for a lump sum refund at tax time.

On the other hand, if you struggle to save or invest money throughout the year and tend to spend it instead, having a larger tax refund might be beneficial for you. It could serve as a forced savings mechanism, allowing you to receive a sizable sum of money once a year that you can then use to pay off debt, cover expenses, or invest in your future.

Ultimately, the best option for you depends on your financial habits, goals, and preferences. If you’re disciplined with your money and want to maximize its potential, minimizing your tax refund and investing throughout the year might be the better choice. But if you struggle to save and need extra help building up your finances, a larger tax refund could work in your favour.

Conclusion

Don’t forget to treat yourself. There’s nothing wrong with using some of the refunds, like $1k, for something enjoyable. You can spend part of the refund on experiences, such as travel, to create lasting memories.

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