It’s the time of year we dread. Tax Time. If you’re through the woods and have filed you’re likely among the 80% of Americans who will be receiving a refund. The only question now is what to do with it.
First, let me explain something. Your tax refund is not necessarily a good thing. It means you gave the government an interest free loan. Shame on you. (On us- I’m right there with you.)
Having now been chastised, what should we do with the money? Or any sudden lump sum?
Just like with any form of financial advice there are a few schools of thought here and they encompass what you can do with any amount of money.
- Spend it.
- Invest it.
- Pay off debt
- Save it.
The buy something nice camp is an ok camp to be in. If you don’t have any financial goals beyond today, it’s great. Get the 90 inch screen you’ve been eyeing, or put a down payment on the most expensive car you can afford the monthly payments for. You’ve won a mini-lottery!
There’s a thick layer of sarcasm on the paragraph above. Splurging on something with your windfall isn’t going to miraculously make your life better. Sure the 90” screen will enable you to binge your latest Netflix series from across the street, but after your neighbor shoos you off her porch what good is it?
You may have expected this windfall, you may have already worked it into your budget. If that’s the case spend it accordingly, but modify your budget going forward so you’re no longer relying on this windfall.
It’s best not to rely on any funds outside of your ordinary salary. It keeps you from getting into a bind if for some reason you don’t get the lump sum… Say your industry is counting on the price of Crude and it suddenly falls dramatically? (Hits pretty close to home for me.)
I have a feeling the majority of folks are treating the IRS like an automatic savings account. Granted it’s hard to find a savings account with interest worrth keeping it in there, there are a few options available. I’ll write a post about them later so at this point just make a mental note to change your withholdings.
The Investment camp is good camp to be in. The rate of return, they argue is higher than what I’m paying to service my debts, so I should put extra money in investments. I agree with them, it makes a lot of sense, IF you’re actually going to invest it t. If not you may as well slink over to the splurge camp, money without a job is destined to be squandered.
We also have the pay off debt camp. They’re advocates of paying off any debt you can with lump sums, student loans, car loans, or credit card debt. I tend to view debt as fire. The higher the interest rate the higher the flames. Which means the flames of credit card debt are licking the ceiling of you house. Use the lump sum bucket of water and put the fire out! If you have student loans, vehicle loans, or even a mortgage, those things are anchors on your cash flow. How much could you save if you didn’t have any debt payments? A lot. A whole freaking lot.
Then we have the savings camp, the camp I’m falling into this year. Boring, I know. But, this will get our emergency fund to the 6 month mark, which will let us toss $500 more cash into our investments per month… (For the time being our investments are in the form of home improvement projects.)
If you don’t have an emergency fund take this opportunity to start one. The average tax refund came in around $2,000.
Sounds like the start of a really nice emergency fund to me.