It’s officially tax season! Wait, you’re not excited? Sure, it probably doesn’t bring as much joy as the holiday season, but it does come with the potential to put some major cash back in your pocket with a refund. The average tax refund last year was $3,120, according to the IRS. That’s a decent chunk of change you can use to improve your financial life.
So what do you do with it? Off the top, commit to treating your refund like regular income, says Andrew Schrage, co-owner of Money Crashers Personal Finance. As soon as you know it’s coming, get to work creating a plan for how to effectively use that money when it arrives. Treating it like a bonus, or extra cash, can lead you to make less responsible decisions and prevent you from getting the most value out of it, Schrage explains. So this week we’re going to talk about putting the money to work in your financial life. And next week we’ll hit some smart spending you can tackle with that windfall, as well.
Pay Down Debt
When extra cash comes your way, paying off debt – especially credit card debt – should be a priority, says Amy Fontinelle of Investopedia.com. “If you have high-interest credit card debt, putting your tax refund towards paying it off will likely give you greater returns than other options,” adds Fontinelle. (The return on your money is equal to the interest rate — so paying off a credit card at 19.9% gives you a return of 19.9% guaranteed. That’s tough to beat.) When it comes to debt reduction, you can use one of two methods: you can snowball, or you can avalanche. The snowball method has you focus on your smallest balances first, so you get the psychological advantage of crossing loans off your list. Here at Savvy Money, we prefer the avalanche where you pay off the debt with the highest interest rate first while making minimum payments on the rest. When it’s gone, move on to the next highest interest rate debt. Either way, see if you can find lower interest rates on any of the debts in your portfolio. Log in at SavvyMoney.com to compare APRs, and see if you can save by refinancing or transferring balances.
Boost Your Retirement Efforts
Paying off your debt is important, but you won’t want to spend all of your cash in one place, says Schrange, because “With the power of compound interest, the sooner you start saving for retirement, the better off you’ll be.” So if debt isn’t a pressing issue for you, then making an extra contribution to your retirement account(s) is your next best move. And if there are matching dollars available, the return on your money can be just as significant.
Start A Rainy-Day Fund
If and when an emergency does strike (i.e. an unexpected hospital stay or costly car repair), you don’t want to make the mistake of either leaning too heavily on high-interest credit cards or tapping into your retirement savings. Both will have you paying dearly down the road. If you don’t have an emergency fund already, make it a top priority in 2016 and use your refund to help get you there. In the best of all possible worlds, you’d have a three-to-six months cushion, but just stashing a couple thousand into your rainy day fund gets you out of financial peril. If the transmission goes or the roof starts to leak you won’t need to put the expense on a credit card.
Get Some Advice
Finally, you can also invest in your financial life by hiring someone — a financial advisor — to help you sketch out a plan for your future. Sometimes having a roadmap is the key to getting exactly where you want to go.
With Max Miller
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