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If you're expecting a tax refund this year, you're not alone. In fact, estimates say that 8 out of 10 Americans will get a refund in 2018. While getting a large refund may feel like getting a bonus, it's important to remember that it's your money; you've just been loaning it to the federal government all year. Therefore, it's important to think carefully about what you do with this money so it serves you best. Treating it as if it's money that fell out of the sky and spending it without care is not a wise decision.
The good news for Americans is that half of the people receiving a refund will actually put it into a savings account, according to estimates. This is good because, by and large, Americans have a history of being very poor savers. In fact, over 70% of Americans have less than $1,000 in savings with a good portion having no savings at all.
On the other side of the coin, about 10% will blow the money on frivolous purchases such as a spa visit. This is obviously not an ideal use of your money.
Money managers advise consumers to think long and hard about what they do with their tax return refund. Among the top recommendations is investing or saving it. However, there are some things you should absolutely stay away from when considering how to spend your refund. Let's look at some of the most common mistakes.
1. Making a Down Payment on a Purchase You Really Can't Afford
Many consumers are tempted to use their tax refund as a down payment on a big-ticket item they really can't afford. Your refund may help you qualify for a new car loan, for example, but you may struggle making the payments. An even worse idea is using your tax refund to make a down payment on a house if you really can't afford it, or if you'll struggle to make the mortgage payments. If there's a very fine line between being able to pay the loan each month and not being able to afford it, even a small unexpected expense could throw you off track. Losing a home to foreclosure is a financially catastrophic event that's not only emotionally traumatic, but will wreck your credit for years to come.
However, if you've been saving for a house and your tax refund puts you over the top of your savings goal, go for it. That's, of course, as long as you have the means to make the mortgage payment each month. Investing in a home at the right time, at the right price, and under the right circumstances, can be one of the best financial decisions you'll ever make.
You should think twice about any large purchase that you can't buy outright. Additionally, even if you can, take careful consideration to be sure that purchasing it is the best use of the money. However, if there's something you really want – if it'll improve your life and it won't cause you hardship – go for it. Taking a dream vacation, for example, may sound frivolous, but that's not always the case. People who take vacations usually feel very satisfied spending a good amount of money on them for the experience that they bring. It's also true that getting away from work and experiencing something completely different can improve your health, your sense of well-being, and make you a more productive person. Therefore, if you don't have a critical use of the money, that cruise you've always wanted to take your family on might be a good bet.
The bottom line here is to avoid using your tax refund as a path to financial trouble. Make sure if you do spend it on a big-ticket purchase that you can truly afford to do so.
2. Making a Risky Investment
Some people feel that their tax refund is just found money, so it's worth it to take a risk in hopes of a big payoff. While you'll be patting yourself on the back if you strike it big, you'll be kicking yourself in the rear if you lose it. Plenty of high-risk investments exist to avoid. Be leery if a friend or relative asks you to invest in a business idea, for example. The fail rate for new ventures is quite high, and chances are strong that if it does fail, you'll never see the money again. Worst of all, you could end up ruining a relationship with a friend or family member.
There are also some investments to be careful of. While investing your money in mutual funds, certificates of deposit, and high-yield savings accounts is probably safe, you should be careful about investing in the stock market. If you do choose to invest in stocks, choose those that have had a stable history. While your return on your investment may be modest, your investment will be less risky.
There are other risky investments to watch out for as well. Cryptocurrencies, while all the rage right now, are extremely volatile and largely unpredictable. Many people are buying up cryptocurrencies in hopes of a big return. Who knows, that might just happen. That's the thing, though; nobody knows which ones will be successful and which ones will not, and there are literally hundreds of cryptocurrencies out there.
3. Don't Gamble with Your Refund
While not gambling with your hard-earned money is always a good piece of financial advice; here, we mean it in a literal sense. Once again, it's important to remember that the government isn't giving you free money; it's just returning it to you after collecting it from you all year. Therefore, it's not wise to risk it all by placing a bet at the casino or at the race track. It's also probably not wise to go spend it on lottery tickets either. However, if you're on a dream vacation and just looking for a little entertainment, using some of your refund as a way to have fun in the casino is not necessarily a bad thing, as long you keep it in perspective.
Another way people can easily waste away their refund is with online gambling. While online gambling isn't legal in the U.S., overseas sites are accessible by Americans. Being able to gamble right from home makes it powerfully attractive, especially for those who have gambling issues. These overseas, online casinos are set up in places where online gambling, or gambling in general, is legal. These offshore gambling locations are also outside of U.S. jurisdiction. Because of this, regulations are a bit lax. This can lead to the danger that the gambling isn't on the up and up, or money deposited or won could be at risk.
Gambling is a powerful addiction many people fall victim to, as powerful as an addiction to drugs or alcohol. If you think you may have a problem, then it's best to seek professional help. Gamblers Anonymous offers many resources including programs and meetings to help people with gambling issues overcome their addiction.
4. Depositing Your Tax Refund into Your Checking Account
While there are worse things you can do, depositing your refund check in your checking account assures that you'll most definitely spend it. Chances are strong that you'll just chip away at it until it's gone. If you're just looking for a little breathing room so you don't have to worry so much about making ends meet, consider putting a portion into your checking account and a portion into a high-yield savings account where it'll earn you some interest. Otherwise, after a short while, it's likely that your refund will be gone. Having a little money to burn often causes us to spend more than we usually would, even if it's not on any large purchases.
5. Don't Borrow Against It
If you use a tax preparation service, you'll most likely be offered a quick refund option or maybe even an advance on the money in the form of an anticipation loan. While it might feel great to get the money right away, this isn't a good idea. These loans usually come with high-interest rates and, most likely, you'll have to pay an application fee. This is essentially just throwing a portion of your refund away.
The IRS will allow you to file your return electronically and receive your refund electronically as well, deposited directly into your checking or savings account. This will happen almost as fast as you could gain approval for a refund anticipation loan, so don't waste your money. In addition, if for some reason your refund is less than expected, you could end up owing more money than you're getting back on your refund.
Do Yourself Some Good with the Money Instead
Instead of blowing your refund on frivolous items that are dangerous for your finances, look for some productive and healthy ways to treat your hard-earned tax refund dollars. Open a good investment vehicle such as a money market account, certificate of deposit (CD), or a high-yield savings account. In addition, a great way to utilize your tax refund is to fund your IRA or other retirement accounts. If you don't have an IRA, now might be the right time to start one.
If you're carrying a lot of debt, consider using your refund to pay down your debt and save the money on the interest that you're being charged. Don't, however, pay off debt, run it back up again over the year, and then start depending on your tax refund to pay off again each year. This can lead to a long-term debt problem with a continuing cycle of running up debt, paying it off, and then running it up again.
Another good use of your refund money is to start an emergency fund. This can help you deal with any financial emergencies that might arise. Financial experts recommend you keep at least three months of expenses on hand in case of an unexpected job loss, medical illness or injury, or another emergency. In many cases, for most people, that's a lot of money, so your refund can give you a big boost toward your savings goal. Once you hit your goal, don't stop saving. Continue to build your cash reserves or divert the money you can save to your retirement account or other investment vehicles. Having cash on hand when you really need it is one of the best ways to secure your financial future.
This year, do something positive with your tax refund. In many cases, it's a nice chunk of change, so use it to stabilize your financial picture. Avoid making the big mistake of blowing your hard-earned dollars on something that you don't need or can't really afford, or anything that'll put your finances in worse shape. It's your money; make it work for you!