There’s Only One Way To Spend Your Tax Refund: Invest It

Updated: May 5, 2021
Some of the links in this post are from our sponsors, and we might earn a commission if you click on one.

If you already have a substantial emergency fund and no outstanding debt to speak of, you might be thinking about using your tax refund for something a little more fun.

There’s certainly nothing wrong with that — and we could all use a pick-me-up after a challenging 2020 — but if your finances were seriously affected by the pandemic, a large tax refund is a great opportunity to get back on track. Before you book those tickets to Cancun, consider some of these options for investing your tax refund instead.

Open An IRA

If you already contribute enough to get the company match with your 401(k), consider using your tax refund to start an Individual Retirement Account (IRA). An IRA is an investment account you can contribute to like a 401(k), but you don’t need to open it through an employer.

There are two types of investment companies you can use: traditional firms like Charles Schwab and Fidelity, or robo advisors like Wealthfront.

If you’re an experienced and knowledgeable investor, Charles Schwab and Fidelity are reputable firms with low-fee funds. If you prefer having an app recommend funds based on your needs, go with a robo advisor instead. These digital, algorithm-driven “advisors” are designed to pick a diversified portfolio for beginning investors.

You can invest the full tax refund at once or spread it out over time, depending on your personal preference. As of 2021, the annual contribution limit for an IRA is $6,000.

Buy Individual Stocks

If you already invest between 10% and 20% of your salary in index funds, use the tax refund as an opportunity to play around with your investments and buy individual stocks from companies you believe in.

Apps like Robinhood and Stash let you purchase fractional shares, which are portions of a stock for investors who can’t afford the whole share. For example, one share of Amazon stock costs $3,362.02. If you only have $1,000 to invest, fractional shares will still let you own part of Amazon. It’s like buying a slice of a pie if you can’t afford the whole thing.

Individual stocks are more volatile than index funds, so you may see the value decrease or increase dramatically. Remember, investing is best though about for long-term goals like retirement. If you plan to use the money for a down payment or a rainy day fund, keep that money in a savings account.

Personal finance journalist Dori Zinn of Blossomers Media said she and her husband used a $13,000 tax refund to invest in dividend-paying stocks. They earned about 10% from all those stocks.

“I would absolutely recommend putting a portion of your tax refund into an investment account,” she said. “I wouldn’t necessarily recommend individual stocks unless you know how to actively manage them. I think a passive account, like any robo-advisor, is a wonderful option.”

Dip Your Toes In Crypto

In the digital space, there’s nothing trendier right now than cryptocurrency. Bitcoin, NFTs and Dogecoin are making headlines — and for good reason.

A basic rule of thumb is to hold between 1% and 5% of your total investment portfolio in cryptocurrency. Open an account with Coinbase where you can invest a lump sum, like your tax refund amount, or schedule monthly recurring deposits. From there, you can purchase shares of Bitcoin, Ethereum and other popular cryptocurrencies.

Add To Your HSA

Most people know an HSA as a special savings account for medical bills, but few know that you can invest the money in an HSA just like you would an IRA or 401(k). Most HSA providers require that you have at least $1,000 in your account to invest the funds.

HSAs are like a hybrid of a Roth and traditional retirement plan, because you can withdraw earnings tax-free and get a tax deduction on contributions. Also, if you contribute to an HSA through your employer, you can even save on payroll taxes.

The 2021 HSA contribution limit is $3,600 for individuals and $7,200 for couples.

Start A 529

Saving for a child’s college education is a top priority for most parents. If that sounds like you, consider using your tax refund to open a 529. This is a special account you can use to pay for qualified educational expenses tax-free.

You can invest the funds in a 529 with an age-based asset allocation that starts out aggressive and grows more conservative as your child ages. Investing the money in a 529 means it will grow as the stock market grows, just like a retirement account.

Plus, most states provide tax credits or deductions for 529 contributions so you can pay fewer taxes.

Hire A Financial Planner

If you want specific investing advice, use the tax refund to pay for a financial planner who can create a custom investing strategy based on your income, retirement goals and current expenses.

A report from the Financial Planning Association found that the average cost of a comprehensive financial plan was $2,250, but smaller scale plans were only $850 on average. Get quotes from a few different financial planners before settling on one. You can find a reputable planner through the XY Planning Network or the National Association of Personal Financial Advisors.

Hiring a professional for a custom investment plan will give you a better sense of what funds fit your needs and how much you should contribute each month.

Feature Image: The Money Manual