The following is a guest post from Greg Johnson at ClubThrifty.com.
So, you just got your tax refund back, and it is already burning a hole in your pocket, huh? I know, I know. It feels like free money, doesn’t it? Well, it isn’t. It has been yours all along. In reality, you’ve just been paid back on the free loan you gave the government, but that is another discussion all together. Still, you got pictures of iPads, Hummers and the Bahamas dancing through your head. You can’t seem to get rid of that money fast enough. Today, Uncle Greg is here to keep you from jumping off that ledge.
It is hard to resist. You want to spend it. A new stereo would be so nice. The furniture stores are all having sales. They want you to come and spend your tax money there. They’re begging you to. You’re like a mesmerized bug flying straight towards an oncoming headlight. You just can’t resist yourself, can you?
Well, SNAP OUT OF IT, bro! Get yourself together. You’ve got bills to pay and this money is just the ticket to help you get caught up. Now, let’s get down to what you should really be doing with that refund.
One reason that big check feels so good is probably because you never have any money. When emergencies arise, you’ve got nothing to fall back on. The slightest unexpected blip can send your financial world into a tailspin and stress you out. So, let’s do something with your tax refund to prevent that from happening. Let’s take that money and start an emergency fund.
You know that feeling you get when something breaks and you don’t have the money to fix it. Your chest gets all tight. You start to panic. What are you going to do? That is where you emergency fund comes in. Ideally, you would like to have somewhere between 3 and 6 months worth of expenses packed away in your emergency fund, which can double as your savings account. Personally, I like to have 6-12 months of expenses covered. However, if you are just starting out, $1,000 to $3,000 is a good goal to set.
The key to a properly functioning emergency fund is to let that money sit there and only use it for emergencies. Going out to eat with your friends isn’t an emergency. Fixing your furnace in the middle of winter is. So, if you don’t have one already, take your tax refund and start building your emergency fund today.
Pay Off Debt
So now you’ve got a little bit of money stashed away for emergencies. Good for you. Instead of going out and spending that tax refund on a brand new LCD TV, let’s first get your debts in order.
Believe it or not, there are both good and bad ways to pay off debt. If you try to do too much all at once, things become muddled and you lose focus, which inevitably leads to failure. In order to build confidence and momentum, we recommend that you use the debt snowball method. There are two ways you can go about that. First, you can start by paying off the debt with the highest interest rate first while making minimum payments on all the other debts. This is the most financially and mathematically sound way of attacking debt.
The second option is to pay off the smallest amount of debt first while making minimum payments on the others. Once it is paid off, you then use that additional money to attack the next smallest debt. This is my favorite option as it is more emotionally satisfying and helps to build excitement. Excitement breeds confidence, and confidence builds momentum. Regardless of the method you choose, put that tax refund to good use and start paying off some debt!
Saving For Retirement and College
Now, you’ve got a fully funded emergency fund and no debt! Spectacular – you are doing great, my friend! It is time to start thinking about retirement. You can invest that money in an IRA if you’d like and watch it blossom into a great nest egg. You’re already saving a substantial amount for retirement? Great. If you’ve got children, perhaps you should look into saving for college. Depending on where you live, you may even be able to get a significant tax break on the money that you save in your child’s college fund. Now, we are really talking about making that tax refund work for you!
So, we’ve covered your emergency fund, you have no debt, AND you are investing for retirement and college? SWEET! Congratulations. I must have mistaken you for somebody else. My apologies.
Now we get to the best part – you can use that money however you’d like. Do you want to take a European vacation? Treat yo self! Is that new Prius calling your name? Go ahead and treat yourself! (But please pay in cash!!!) Since you’re already a financial rock star, you might want to take a look at changing your tax with holdings on your W-4 Form. You don’t need to be floating the government an interest free loan every year when you could be investing it and earning interest or income. You can take care of your savings all by yourself, thank you very much.
This year, don’t make the mistake of blowing through money that can right your financial ship. Make that money work for you and start getting ahead today. 2013 may just be the year your life changes and you never have to worry about financial hardship or strife ever again.
This article is a guest post from Greg Johnson – a proud husband, father, and debt crusader who is in the process of becoming debt free. He is the co-founder of the personal finance website Club Thrifty, where he brings the awesome sauce each and every day. He also loves chocolate.