In 2019, the average tax return was a little over $3,000 — which, no matter your income level — is nothing to sneeze at. I mean, an extra $3,000 added to your budget could cover a lot of shoes, that Peloton bike you’ve been eyeing, or even a weekend getaway that your family so desperately needs.
But before you go on a shopping spree or otherwise splurge with your refund, you might want to consider some other options — like using that cash for home improvements or paying down your student loans.
If you just received a big, fat tax return and don’t know what to do with it, here are my top three recommendations to put it to good use.
Sock it Away
This is probably the single most important thing you can do to maintain strong financial health and prevent yourself from sliding into debt. Far too many of us don’t have a sufficient emergency fund. If your car breaks down, or you need to pay a large insurance co-payment, you need to have money on hand to do just that.
Your emergency fund should contain 3 to 6 months of living expenses and should be held in an easily-accessible account, such as a savings account or a money-market account.
I’ll agree that this is the most boring thing that you can do with your tax return. But keep this research from the JP Morgan Chase Institute in mind. Research has found that the amount of cash you have in the bank is a more useful predictor of mortgage default than home equity is. People with three to four months of mortgage payments in the bank were far less likely to default than those with less than one month of payments.
Don’t be sidetracked by the fact that money in the bank doesn’t earn much, either. Remember – a bird in hand is worth two in the bush. Better to have the funds on hand than have to charge an unexpected expense and then pay interest while you wonder how to pay for it.
Bye-Bye Balance
If you have enough in your emergency fund, consider using that tax return to pay off some credit card balances or other outstanding bills.
In 2019, consumers spent an average of 10% of their disposable income on debt payments such as credit cards, car loans, student loans and other personal loans. Freeing up this money gives you breathing room to work on your other goals.
My two favorite ways to apply your tax return toward your debt are paying the highest interest rate loan first or paying the smallest balance first.
Paying off your highest-interest-rate debt will save you the most money mathematically. Paying off lots of little bills can be more satisfying than paying a large chunk on one bill, and it can simplify your monthly bill-paying process. This provides you with a psychological sense of victory that keeps you motivated to continue the process.
Both options will help you make significant progress toward eliminating your debt, so either one is a good choice.
Home Sweet Home
Once you are comfortable with some savings, and have the credit under control, do something good for yourself.
For around $1,000 or less, you could make updates to your home that will improve your quality of life. You could repaint a room, fix a leaky faucet, buy a programmable thermostat, add new landscaping, or even pay someone to KonMari your stuff.
These enhancements make your space more comfortable and functional for your family, and they add value to your home if you decide to sell it later.
The most important take-away here is to resist the urge to splurge first. We’re all familiar with the phrase, “treat yourself”. While it’s not a bad idea to spend money on yourself for fun here and there, it might not be the best way to spend your tax return.
So, take a hard look at your finances and figure out what to do with your tax refund so it improves your financial standing — instead of staring blankly at your bank statement a few months from now wondering where the money went.
Pathfinder Planning LLC is a registered investment advisor in North and South Carolina. For more information, visit www.pathfinderplanningllc.com.