top of page

Don’t Spend that Tax Refund!

Updated: Feb 2, 2023

My last post talked about taking control. I mentioned some steps to take immediately, including starting to close the gap between where you are financially today, and where you want to be. Sometimes, that is easier said than done, and we need that extra push to get started. Your tax refund is the perfect “push” that you need to jump start your investing.

We are in the throes of tax season and the IRS estimates that the average tax return in 2015 will be $3,295. It was $3,116 in 2014. Of course, we’re not all going to see that exact amount, but whether it’s $500 or $5,000, you can put that money to work. Take a look at the chart below to see the growth of tax refunds of $500, $1000, $2500 respectively over 25 years, assuming an 8% return (reasonable long term average return for stocks).

First, let me get something out of the way. I am assuming that you have at least $1,000 saved in a rainy day fund. If you don’t, then that is the first place that your tax refund should go. Experts advise that you should have at least 3 months of expenses in your rainy day fund, but I think you should determine the right amount for you. Some people have as much as a year of expenses in their rainy day account! $1,000 is the minimum amount you should have, to provide you with some breathing room, in case of an emergency. Remember that even though investment accounts are liquid, it may take a few days for the proceeds from a sale to settle, and the money won’t be available immediately in an emergency.

Now, on to the main topic. Many brokerage firms and mutual funds provide the opportunity to invest routinely or systematically. It’s a great way for you to automate your investing and also allows you to practice DCA (Dollar Cost Averaging), where you buy an investment at regular intervals with the focus of accumulating shares. One of the potential drawbacks for new investors is that the brokerage firms and mutual funds sometimes require large initial deposits into the account, or the trading fees don’t make it worthwhile for you to invest that monthly $50 or $100. By using your tax refund, you have a chunk of money ready for initial deposit into the investment account, and are better able to meet the initial deposit requirement and you’re able to reduce the impact of the trading fee on your investment.

So, rather than put off investing till you have enough money saved, and potentially spending that money on something else along the way, jump start your investing by using your tax refund.

Of course, there’s the question of who to invest your money with and what type of account and investments to invest your money in. Let’s take a look at each of these considerations.

Who to invest with: Open an account with a brokerage firm. You can choose from an online brokerage firm like ShareBuilder or Fidelity, or you can choose from a traditional brokerage firm with Financial Advisors. Online brokerage firms have lower trading fees and you also have the option to speak with an advisor when you need one. Visit the tools section of my website for a comparison of online brokerage firms and their fees

What Type of Account: Should you invest in a traditional IRA, Roth IRA, or a taxable investment account? The answer depends on how long you want to keep the money invested and for what purpose.

Both traditional and Roth IRAs are retirement accounts where your money grows tax free and there are penalties for early withdrawal. The difference between a traditional and Roth is that contributions to a traditional IRA are tax deductible (income limits apply), but taxes are owed when money is withdrawn, while contributions to a Roth IRA are not tax deductible, but taxes are not owed at withdrawal.

A taxable account has no tax advantages or penalties. Taxes are owed on any dividends or distributions to the account the year they occur, and when the investment is sold, taxes are owed on the gains (you can also deduct losses if you itemize deductions on your tax return).

What Type of Investment: There are various investment options. The most common ones are individual stocks, bonds and mutual funds. Your best bet is to go with an ETF (Exchange Traded Fund) or Index Fund that tracks the total market or the S&P 500. ETFs and Index funds have low expense fees, and they provide diversification. Many brokerage firms offer free ETFs i.e. you don’t pay a fee to buy or sell them. That’s a huge bonus!

To learn more about Brokerage Firms, account types, and types of investments, pick up a copy of my book Fifty Shades of Green where I explain these and more investment topics clearly and simply.

In conclusion, don’t spend that refund. Instead, make it work for you! Open an investment account or fund an existing one and jump start your Financial Independence.

Topics covered:

  1. Types of investment accounts

  2. Types of investments

  3. Types of brokerage firms

1 view


bottom of page