You know the feeling. Tax season rolls around, we sit with anticipation waiting for extra cash to hit our bank accounts. You start daydreaming, maybe even planning on what to spend it on – maybe you spent it already. It is basically extra money right? Yeah basically, except it’s not.
This “extra money,” is not extra at all. It is money you worked for, but the government held for some time before giving it back. It is exactly what the name indicates – a refund (I know; I am a genius). Too often the misconception of what a tax refund is creates in us a free like mindset that leads to unwarranted spending. A sudden lump sum getting dumped into our accounts makes us feel that budgets have no jurisdiction, or power over our spending – I know the feeling all too well. After all, an unaccounted sum of money deposited into your bank account has to be extra cash right? Unfortunately, no. I know, I find that just as annoying as you probably do.
This is something I have struggled with in the past. Every year though – come February – I remind myself that this refund was mine all along, that it is not a bonus, and is already accounted for. Why would I put myself through this you ask? It is simple, I am beginning with the end in mind. I have learned that a tax refund does not give me an excuse to spend money mindlessly, and that being smart about where I place these funds gets me one step – or several steps – closer to financial independence.
In order to help you escape the annual “spend your tax refund as fast as you can before the IRS changes their mind” practice, I have listed below a few questions I often ask myself when faced in any “Look! Extra money” situation. These questions have proved valuable in helping me stay on track to meet my financial goals. I hope it will do the same for you.
1. Is my Emergency Fund (aka Rainy Day Fund) in shape?
This almost seems self-explanatory, yet USA Today reports that 7 in 10 Americans have less than $1,000 in savings. Not very surprising considering it is well documented that Americans as a whole have bad saving habits. Most experts agree that one should have at least 3 to 6 months of daily expenses saved up in case of emergencies (layoff, medical bills, injury, etc). It is also estimated that we will all have at least one financial crisis or setback in our lifetime. One financial crisis plus no savings equals disaster.
Having an emergency fund is crucial to maintaining healthy finances and protecting your future. Tax season is the perfect opportunity to sit down, assess your savings, and if found lacking, contribute to your financial stability. Asking myself this question has convinced me to create a solid safety net, and has saved me from countless headaches.
2. Do I owe money?
Another important question. Very few of us now-in-days go through life without debt. I ended up with a lot of debt following graduate school, and found this question constantly looming in the back of my mind. Although at times depressing, it served its purpose. It pushed me to stay aware and understand the reality of my situation. It encouraged me to weigh and prioritize my responsibilities. It did not allow me forget that I still had debts to pay, and that using the money extravagantly did not make much sense.
The instant gratification culture we live in is an obstacle; it makes it hard to meet financial goals. It places more value on the here and now versus investing and building for the future. Do not get me wrong, it is important to live in the present, but not at the expense of your future. Placing a good chunk of your tax refund toward outstanding credit card debts or student loans will go a long way. It may not feel like it at the time, but it will payoff when you are out of debt years ahead of your friends.
Dave Ramsey’s “Total Money Makeover” is a great read that provides easy to follow steps to get out of debt along with so much more. Click the link to take a look.
3. What will my return on investment be?
Some of the best advice I ever got was to go through life making decisions based on the best return on investment (ROI). This applies to everything. Your time, relationships, reading, money, you name it. In all areas of life, we are to be looking for the best ROI.
Think long and hard on where your money will do the most good. What will your return be? Will spending your refund buy you quality time with your family? Will it rid you of long-standing credit card debt? Or will it provide you with a constant stream of passive income? Obviously you have to weigh this against your own values and priorities. For instance, treating your family to a vacation can be completely justifiable in some cases. However, do not to try to rationalize your way into spending the money on what you want, and do not need. Rather spend the money on what will be best for the your overall health, and your family’s future.
4. Is there a foreseeable miscellaneous expense?
How many times have you been caught off guard by a broken car, faulty home appliances, or a home repair? How many times have you tried saving for something big such as a house, car, or computer? Tax season would be a pretty good time to consider saving a portion of your refund in anticipation of a foreseeable expense. Foresight is key to maintaining financial stability.
Asking yourself this question will cue you to set apart time to assess the condition of your home, devices, and machinery – saving you annoyances in the future. Of course, there is always your emergency fund. In the case you are unable to foresee any breakdowns, your emergency fund has your back – that is what it is for.
5. Are there equivalent or equal products ?
If after going through the above question you find you are adequately prepared, why not treat yourself? Whatever the product, I suggest you spend time searching for brands of equal quality, but bear a lower price tag. Do not get fixated on name brands or trends. 8 out of 10 times there are good, or even better alternatives to whatever product you have set your mind too. You want to get the biggest bang for your buck? Be smart, invest time and do your research. Ask yourself if you really need that MacBook pro? Or will the HP with the same specs do just fine?
Asking these questions will often prove hard, they might even make you feel guilty at times. My hope is however, that it will also help bring your mind back to what is important. That they succeed in prompting you to make the wisest decision for you, and your current or future family.
One of the best books I could recommend on the finance subject is “The Millionaire Next Door.” It provides key insight into the lives of the rich and how they built their wealth. Truly eye opening. I would recommend it to my own family, in fact, I have. Click here to check it out.
What did you think? Can you come up with any other wise uses for your tax return? Comment below.