I’m a Financial Advisor: Here’s the 5 Smartest Things To Do With Your Tax Return
The year has just begun, and while you may still be catching up with post-holiday debt or putting all your focus on staying on track with your New Year’s resolutions (especially those super important financial ones!), it’s time to face a possibly upsetting reality: tax season is fast upon us.
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Tax season kicks off on Jan. 29 this year, which will be here in the blink of an eye. While getting your ducks in a row to adequately file your 2023 income tax return, you should also start planning what to do with your tax refund, if you plan on getting one.
Though it’s tempting to fling this little annual windfall at something fun, like a vacation or a well-deserved gift for yourself, that’s hardly a savvy move, money-wise, particularly not if you’re living on a frugal budget.
What are the smartest things you can do with your tax refund? GOBankingRates asked two financial experts for their thoughts. Here’s what they told us.
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Build or Add to Your Emergency Fund
Most Americans are sorely lacking when it comes to their emergency funds.
According to a recent survey by LendingTree, just about half of Americans don’t have enough in the bank to cover a $1,000 emergency, and many would resort to using a credit card to cover the expense.
So, if you’re behind on your emergency fund, one best move to take with your tax refund is to contribute to it.
“Aim for three to six months’ worth of living expenses to cover unexpected events like job loss or medical emergencies,” recommended Taylor Kovar, a Certified Financial Planner (CFP) and the founder and CEO at Kovar Wealth Management.
Pay Off High-Interest Debt
High-interest debt is a burden that the vast majority of Americans bear, and this debt is only increasing across consumers.
Not only is the burden of high-interest debt heavy, but it’s also toxic and creates a vicious cycle that can break the bank; every month that you don’t clear the debt, it just goes up and up.
It would be wise and beneficial to use your tax refund to knock down this debt or wipe it out entirely, if possible.
“Use your refund to pay off or reduce high-interest debts, such as credit card balances,” Kovar said. “This reduces interest costs and can improve your credit score.”
Put It Toward Your Retirement Fund
If you’re out of the clear with debt and you have enough saved in your emergency nest egg, Kovar said, “Consider contributing to your IRA or another retirement account.”
Kovar added, “This can help secure your financial future and may offer tax benefits.”
Donate to Charity
Yes, donating to charity can be enormously fulfilling on a personal level — and it really is a way of turning money into something truly good — but as Kovar highlights, charity donations may offer tax deductions for the tax year 2024.
If you put your tax refund toward charity, you’ll thank yourself this time next year!
Invest It in Your Stock Portfolio (Buffett Probably Would)
Perhaps the smartest thing you can do with your tax refund (provided you have no high-interest debt and a solid emergency fund in place) is to invest it in a diversified portfolio of common stocks.
“In fact, act like you didn’t even receive the refund and immediately invest it,” said Robert R. Johnson, PhD and professor of finance at the Heider College of Business of Creighton University. “In essence, out of sight, out of mind.”
As Johnson explained, “According to data compiled by Ibbotson Associates, large capitalization stocks (think S&P 500) returned 10.1% compounded annually from 1926-2022. Over that same time period, long-term government bonds returned 5.2% annually and t-bills returned 3.2% annually.”
Therefore, the surest way to build wealth over long time horizons is to invest in a diversified portfolio of common stocks.
Note that this advice is consistent with wisdom lent by Warren Buffett, who said that for building retirement savings, “Consistently buy an S&P 500 low-cost index fund. I think it’s the thing that makes the most sense practically all of the time.”
Buffett is so loyal to this advice that he even intends to hold to it post-mortem.
In his 2014 letter to Berkshire Hathaway shareholders, Buffett has shared publicly that when he passes away, “My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors.”
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This article originally appeared on GOBankingRates.com: I’m a Financial Advisor: Here’s the 5 Smartest Things To Do With Your Tax Return