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Filing taxes is one of the most universally loathed chores out there, but many people are rewarded with a refund. If you’re one of them, you’re free to use that money however you want — to pay bills, splurge on a big-ticket item, or grow your savings. If you don’t need that money right now, the last option might be your best one.
Below, I’ll look at how you can turn your tax refund into $25,000 or maybe even more with just a little bit of patience.
Image source: Getty Images.
Your money should work for you
If your goal is to grow your wealth, you don’t want your savings just sitting idle. You could stash it in a savings account and won’t have to worry about losing money there. However, there’s a strong possibility that it won’t grow as quickly as the rate of inflation and your savings will lose buying power over time.
On the surface, investing might seem riskier, especially in volatile times like these. But over the long term, the stock market actually does quite well.
The S&P 500 index has a compound average annual growth rate of over 10% over the last 30 years. During that time, it saw losses of up to 37% in a single year and gains of over 33% in others, but the general trend was upward. As long as you’re able to invest your cash and leave it alone for a decade or two, you’re probably going to make a lot of money.
Let’s say you qualify for the average tax refund, which at the moment is about $2,323. If you invest that money in an S&P 500 index fund that earns about 10% per year over 25 years, you’d end up with over $25,000. And if you left that money alone for another five years, you’d be looking at about $40,000. Another five years after that and you’d be at $65,000.
The point is, the longer you invest your money, the more it can grow over time.
It’s tough to think about tying up your savings for decades, especially if you can think of ways to spend that money right now. But a $25,000 return would be over 10 times your initial refund, and that kind of cash could help you cover a lot more of your expenses later on.
The best part is, after you invest your money, you literally don’t have to do anything. Just sit back and leave your money alone until you’re ready to withdraw it.
How to get started
If you want to invest your tax refund, there are really only two decisions you need to make: what you want to invest in and where you want to keep your money.
You could keep your funds in a taxable brokerage account, which would enable you to invest in just about anything you want and withdraw your money at any time. But you’d owe capital gains taxes on your earnings if you do this.
If you don’t plan to spend your money for decades, a retirement account might be a better fit. For a one-time deposit like a tax refund, an IRA is the best choice. You can choose from either a traditional IRA, where your contributions reduce your taxable income for the year and you pay taxes on your withdrawals, or a Roth IRA, where you pay taxes upfront in exchange for tax-free withdrawals later.
IRAs also give you plenty of flexibility to invest your savings how you want to. You can choose individual stocks if you feel comfortable doing this, or if you don’t, an index fund is a great option.
This is a bundle of investments that mimics the performance of a market index and contains hundreds of stocks, so your money is well-diversified. And they’re usually pretty affordable, too. The best S&P 500 index funds only charge you about $3 per year on a $10,000 portfolio.
Investing your 2021 tax refund is a great way to get your feet wet if you’re new to investing. If you make a habit of investing your refund every year, along with a small amount of each paycheck, you can begin to build a nest egg that can carry you through years of retirement. Start small, and look for opportunities to set aside more cash every year for the best results.
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