So you did it. You’ve completed your tax returns. Now you’re getting a refund, and it’s burning a hole in your pocket. But is there a best way to divvy up your “windfall?”
Don’t be too excited…
First of all, a tax refund is not necessarily a windfall. A tax refund is usually an overpayment of taxes. This refund amount can be a function of the number of allowances on the Form W-4. A refund could indicate that too much is being withheld from each paycheck.
Often people do this as a form of forced savings, even though it’s a 0% investment. Others may have experienced a change in life. For example, a divorcee may now be filing as a head of household. For 2018, that’s a standard deduction of $18,000 as opposed to the $12,000 for single filers.
But…
Assuming we’re not on the 0% IRS savings plan, what do we do with a sizable refund? I am reminded of Warren Buffett’s 90/10 strategy. Essentially, 90% of capital should be investeded conservatively. The remaining 10% can be used for riskier investments.
In the context of a big tax refund, 90% could be used deploying the Baby Steps. Establish a baby emergency fund of $1000 (Step 1). After that, paying off debts starting with the smallest debt (Step 2. After that, adding to (or completing) a full emergency fund. After that, invested for retirement. After that, college funding. After that, principle payments on the mortgage.
After that, the remaining 10% can be used for riskier investments or giving. Hey, ya gotta have a life!
What would you do with your 10%?