There is nothing quite like a tax refund to put a smile on your face. It's almost like it's free money. But once you get it, you have to decide what to do with it. Rather than blowing it on a big screen TV or a trip to Cancun, you might consider using your tax refund to make your financial situation more secure by increasing your savings or reducing your debt.
The decision to pay down debt or build up savings is a personal one that should be dictated by your situation. Before you make a decision to do either, take stock of where you are financially. You need to know your net worth, which is what's left over after you subtract your liabilities from your assets. You should know your monthly cash flow, which is what's left over at the end of the month after you pay all of your bills. You should also have a budget that tells you how you plan on spending your money each month.
When it comes to paying down debt or building up savings, financial experts come down on both sides fence. One factor to consider before making that decision is whether or not you have an emergency fund in place. An emergency fund is a minimum amount of money in a safe, readily accessible account, such as a savings or checking account, that you use to handle minor financial hiccups, for example, if a tire blows out or if your washing machine dies. Your emergency fund keeps you from going into additional debt for unexpected expenses.
High Interest Debt
The argument can be made that you are better off paying down high interest debt, such as balances on your credit cards, rather than putting your tax refund into savings. The comparisons seem to bear the argument out. If you put $1,000 into a saving account earning 2 percent interest, at the end of a year you would earn $20. Your $1,000 credit card balance, with an interest charge of 15 percent, would cost you $150 during that same year. You'd save $130 by paying off your credit card rather than putting the money into savings.
You can't really make the decision between paying down debt or putting your tax refund into savings in a vacuum. Run your financial situation numbers using a variety of different scenarios. If you have enough money in savings to handle minor emergencies that may arise, you'll probably be better off paying down your debt. If you pay off debt without having an emergency fund and an unexpected financial need arises, you are likely to go back into debt to pay that need. Your best bet might be a combination. Save a portion of your tax refund and use the rest to pay down your debt.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.