Each year, the average American gets a tax refund of $2,800. When you receive your tax refund, you may be tempted to spend it all right away or use your tax return to pay off debt. However, if you want to keep up with inflation, investing your tax refund is a better idea. There are several ways to invest your tax refund to help you grow your money while keeping up with inflation, but here are a few tips to help get you started.
Diversify your portfolio
Many people think diversifying their portfolios is a waste of time because they believe that the stock market will always go up, so it’s best to put all their money into stocks or mutual funds.
However, this is not always the case. Inflation can cause the value of your investments to decrease over time, leading to a loss so it’s a better option to diversify instead and put your tax return into various types of investments. Ideally, your portfolio should include a mix of stocks and bonds. By investing in various types of investments, you can help combat inflation and protect your money.
There are a number of different ways to divvy up your funds, and each has its own benefits and drawbacks. One option is to invest in stocks or mutual funds. These investments tend to grow over time, which will help you keep up with inflation but are generally the riskiest. Withdrawing funds from them early could also subject you to capital gains taxes which drastically reduce any profits you’ve earned.
There’s also the option of using traditional savings accounts, money market accounts, and CDs. Both savings and money market accounts offer low interest rates and are typically FDIC-insured, which means you are guaranteed to be paid back your money if the bank fails. However, they have slow growth, and their interest rates are based on the rates set by the Federal Reserve.
Of these, certificate of deposit (CD) accounts offer the highest interest rates but also lock your funds up for a duration of time until the CD matures, typically a few years. If you choose to invest in a CD, carefully research the terms before investing.
Use a tax-advantaged account
There are several tax-advantaged accounts available to help you combat inflation. The most common is an Individual Retirement Account (IRA). An IRA allows you to invest money in stocks, bonds, and other securities without paying taxes on the gains. This can provide a significant return on your money over time, helping you keep up with inflation.
Another option is a 401(k). 401(k) plans allow you to invest money in stocks, bonds, and other securities with the help of your employer. The benefits of a 401(k) plan include tax-deferred growth and the ability to withdraw money tax-free if you leave your job or suffer financial hardship.
However, these tax-advantaged accounts are typically used for retirement purposes and can carry penalties for any withdrawals that are taken before retirement unless you pay back what you withdraw.
The bottom line
You can use your tax refund to combat inflation and grow your wealth. By investing in assets that keep up with inflation, diversifying your portfolio, and using a tax-advantaged account, you can make the most of your refund.