Investing Your Tax Refund For A 1,000% Return

Mauna Kea, HawaiiIn the article, “How To Get Over Your Fear Of Investing” I mention how your risk tolerance decreases the more capital you accumulate. When you were rocking a $100,000 net worth as a 30-year-old, you had no problems investing 30% of your net worth in your employer’s promising stock. But now that you’re 50 and less enthusiastic about working for decades more, investing 30% of your $1 million nest egg doesn’t seem like a good idea.

The tax refund actually provides for a great opportunity to swing for the ROI fences every single year, no matter your age or net worth. Given that the average tax refund is only around $3,000, many people just blow it on material things like shoes, clothing, gadgets, and LED TVs. It’s not necessarily a bad idea to use your “bonus” money to buy something tangible: any of these things can provide solid utility until next year’s refund. Alternatively, going the traditional route of paying down debt or increasing a depleted emergency fund is also fine, just terribly unexciting.

Now if your tax refund was a whopping $100,000, I’m willing to be that your approach to spending it would be substantially different! Some would unwisely go out and spend the money instantly on a luxury automobile; most, however, would probably give considerably more thought to the question of how to deploy such a large sum. Things like paying down a mortgage, investing for retirement, buying a home, putting money away for a child’s education, or helping out a loved one all come to mind with this level of money. But most people will never receive such a large refund, so the point is moot (sorry!). The $100k refund simply provides a mental exercise that highlights how our spending habits shift when dealing with different levels of money.

Although a tax refund often feels like a nice windfall each year, it’s actually been your money all along. And how boring it is to just invest that money (now that you finally have it) in the stock market for a potential 8% historical return. Of course if you’ve got revolving credit card debt with interest rates in the teens or higher, certainly give that a whack. But as a Financial Samurai reader, I’m thinking you guys are savvier than this.

A 10X RETURN ON YOUR MONEY

Please spend some time reading, “The Most Lucrative Ways To Spend Your Tax Refund.” Each of the four ways I suggest provides a return ranging from 1,000% to priceless, in my opinion. While you probably can afford to take bigger risks with $3,000, my suggestions for investing your tax refund probably have the lowest risk of all—and definitely the biggest payoff!

Use your refund to build better relationships at work and at home. If work is going well and your love life is swell, everything else just takes care of itself. All this talk about aggressively investing your savings into stocks and bonds for a more secure financial future is just gravy, because you’re living in a wonderful moment.

When was the last time you took your boss out for lunch (on you)? I bet for many people, the answer is “never”. But as I’ve highlighted before in, “How To Get Ahead In Your Career” that’s exactly what some of the most keen people in any organization do. If you could pave your path to a promotion and a raise, the return on a fancy $100 lunch or multiple lunches with your boss is probably closer to 10,000% instead of just 1,000%.

The happiest moments in my life are when I’m surrounded by family, friends, and loved ones. Think back to those family holiday get togethers, or those great adventure vacations with your partner. What a blast! How about those momentous occasions when your parents proudly watched you graduate from high school or college? These are moments I’ll never forget. It’s curious how we drift apart as we get older; life gets in the way, I guess. Spending money to be with friends and family can’t be beat.

TAX REFUND SPENDING PLAN

Tax Refund Table

My refund this year is relatively large because of deferred compensation that is paid in a lump sum once a year while no longer having a lump some severance payment. The IRS thinks the lump sum will occur every month, and therefore taxes the amount at the top tax bracket. The reality is I earned much less to the point where AMT was only a couple thousand dollars.  One day I hope AMT will be zero, if Congress can raise the income trap.

I see the annual tax refund as a defined pool of money that should be wisely spent on others as well as yourself. If you throw the refund into your pool of investments, its efficacy disappears. You won’t even be able to feel the joy of a 10% return. But if you invest the refund on relationships, a better life awaits.

Readers, how are you planning on spending your tax refund? If you didn’t get a refund, are you OK with owing? The optimal situation is +/- $3,000 imo. Everybody finished doing their own taxes yet?

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. writing2reality says

    Raise the AMT threshold and give up “free money”? Congress won’t be making moves like that since AMT affects the wealthier more than anyone else. As you say yourself, don’t go against the masses!

    As for my refund, I rarely get them. I tend to schedule my withholdings and tax payments so I owe between $500 and a $1,000 per year. I prefer not to be in the business of giving out interest free loans for a year.

  2. SavvyFinancialLatina says

    I don’t think I’m going to get a big return. If it we do, it’s going to fund our IRAs or brokerage accounts. Something boring, but that adds value. Last year we used our hefty return to fund our down payment. It was awesome!

  3. Kathy says

    No refund due. We hate for the government to have interest free use of our money which they mostly waste. So we plan and schedule withholding and estimated payments to either get no refund and have a zero balance due, or we owe. As long as we avoid the underpayment penalty, owing is fine with use.

  4. freebird says

    Usually I owe but in 2013 I overpaid by more than you did. I’m letting the IRS roll it into next year, I’ve taken a few capital gains in 2014 (mostly not by choice) so it’ll come in handy to avoid a penalty next year. As for “interest free loans”, my bank 1099 shows a balance like this earns maybe a Big Mac in a year.

  5. Mark Ferguson says

    great article! Not only will taking out your boss to lunch make a great impression on him. But it may lead to a friendship and having friends in high places is a great way to get ahead.

  6. Holly@ClubThrifty says

    We are getting a pretty big refund this year, mainly due to the fact that I overpaid on my estimated taxes and the huge loss we took on our rental properties in 2013. We are going to invest about 80% and use the rest for our upcoming vacation.

  7. The First Million is the Hardest says

    I haven’t done my taxes yet, but expect to get a modest refund thanks to the mortgage interest deduction. Normally I just throw my refund into savings or my brokerage account, but this year I have a feeling it’ll be going towards wedding expenses.

  8. s says

    No tax refund this year. Owe about $1,000. Not to bad, I knew I would owe a little. Unfortunately, can’t take real estate losses due to $150,000 threshold.

  9. Done by Forty says

    A clever approach, Sam. The logical side of me wants to say that money is fungible, so a tax refund should be applied like any other money. But I know there are benefits to mental accounting, too. Buying happiness is almost never a bad idea: if a separate bucket allows you to do so, then great.

    We’re discussing what to do with our $700 return, so this is a timely post. Thanks for the perspective!

  10. Jamie V says

    I’m going to open an account at Vanguard and invest it all in a fund. I have an IRA and 401K, but nothing yet to help support me when I decide to be FI before retirement age. It’s a small step but important nonetheless and I’m happy to be able to do this.

    • Financial Samurai says

      Not a bad move. Small steps become bigger steps. But if you have nothing at this stage, I’m assuming you are younger. Might as well use some of the money to take out colleagues and find yourself a mentor for some huge gains down the road!

  11. Mr. Utopia says

    What? You don’t get $100k refunds, Sam? Surely you must know some tip, trick, or strategy to accomplish getting one that massive ;-)

    I’m among the “boring” types of people. The refund (which is usually on the small side since I don’t care to give the government a free loan) hits my account via direct deposit and I pretty much just treat it as a paycheck. In other words, it becomes a regular part of our cash flow…no different than say a year-end bonus would (and those bonuses are usually just as small as a tax refund!).

    • Financial Samurai says

      Ahhh, yes that is boring, but that’s OK. Because I am boring basically every month w/ my money (50%+ saver still), I like to use the tax refund to invest in things I perhaps wouldn’t normally do. The main thing really is spending the money on others.

      I hope to one day make millions to one day be able to get a $100K refund!

  12. Big Guy Money says

    This year the money is going towards the next goal – replacing our 2-door 1999 Hyundai Tiburon. Our kids are (almost) 8 and 9 now, and don’t fit too well. I’m actually not sure I’ve EVER fit very well in that car.

    And yes, did our own taxes once again. We’ve never paid for our taxes to be prepared.

  13. Steve says

    Hi Samurai!

    For me, Vanguard VTSAX 100% deposit into a taxable account. I’m 45, but my 401k size is under par currently; so I started saving into a Spousal IRA and a ROTH IRA for me (now all 3 fully funded)… to ensure I have a safety net or some cushion, I created a taxable account and it primarily has VTSAX in it….

    Outside of that, I would increase my cash position in Cap One 360… This account allows me to have piece of mind….

    Sure wish I was following blogs like this sooner… Once I’m caught up, I have different thoughts about how I will spend money…

    Best Regards,

    Steve

  14. Chuck@Tortoise Banker says

    I dig it. Usually I just think of one purpose for my tax refund… like increasing emergency fund, or upping 401k contribution for a month or two, but your ideas inspired me to spend some on my relationship at home. Thanks

  15. Bryce @ Save and Conquer says

    We almost never get a tax refund, and it’s no different this year. We plan our tax withholding so that we will owe a little bit to the Fed and State come April. I would rather have the use of my own money throughout the year than give the government a loan by paying too much tax.

  16. Ricky says

    The problem with all of these “solutions” to a tax refund assume that the refund is some sort of bonus. It’s not. It’s your money that you’ve already earned. You just let someone borrow it interest free for a while. Before thinking of how to blow it, you should kick yourself in the butt for letting anyone borrow your hard earned money for free, especially while you are still working. If you are no longer working and have enough money to live on plus let others borrow some for free, by all means you should at that point.

    I do like the non-traditional investment approach that most don’t think of though. The problem it is it practically all risk since there is no “data” on whether your boss will suddenly like you much more and give you a raise or continue to like you. Being a “suck up” might also weaken your relationship with certain colleagues even if it strengthens your relationship with your boss.

    • Financial Samurai says

      I address this your money thing here, “Although a tax refund often feels like a nice windfall each year, it’s actually been your money all along. And how boring it is to just invest that money (now that you finally have it) in the stock market for a potential 8% historical return. Of course if you’ve got revolving credit card debt with interest rates in the teens or higher, certainly give that a whack. But as a Financial Samurai reader, I’m thinking you guys are savvier than this.”

      The average money market interest rate is less than 0.2%. I’d much rather have every single American get a tax refund than owe because Americans have shown they can’t save (less than 5% national savings rate).

      You’ll just have to trust me on spending money investing in relationships Ricky. They pay off BIG TIME in the end if you do it properly. Care to share your financial stats and career so I can get more perspective on your cynicism? Thx

      • Ricky says

        But what’s wrong with a historical 8% return? “Now that you finally have it” is where I see the disconnection. You could of had it all along if you had only done the research and had been prudent about your taxes all year (I am not directing this towards you, the writer, but towards those who are oblivious to the gov borrowing their money for free).

        Don’t get me wrong, I 100% believe in networking and strengthening relationships with your loved ones as well as business relationships. I am just saying it isn’t as quantitative as an 8% return. I was simply pointing out that by strengthening some relationships you can diminish others concurrently.

        As far as stats, I’m not sure what you’re looking for :P I am nearly FI and have made most of my money working for myself. I currently work part time at a local cell retailer because I am finishing up school this semester and did not enjoy computer consulting anymore. I have no student debt or any debt of any kind. My savings rate is nearly 80%. I haven’t started a traditional career yet where there is actually room for growth so it suppose that’s what caused me to make a rash judgment.

        • Financial Samurai says

          Because 1,000% is greater than 8%.

          Nice job becoming FI while still in school. You’ll have to share how you did that.

          I think if you had a traditional career, think your appreciate more my advice.

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