Have you filed your federal income taxes yet? Are you getting a refund this year or will you have to pay? While it is probably better to owe taxes then receive a refund, it may be time to put that money you are getting back to work. A large tax refund is the perfect time to start making your assets work for you to build wealth.
Investing a tax refund or any other large lump sum payment can help kick-start a new source of income for you. Using money that is not part of your normal pay or budget is nice because you shouldn’t be counting on it to pay the bills. It may just be the perfect time to start down that path towards financial independence.
3 Ways to Build Wealth from Your Tax Refund
Below are 3 different ways that you can invest your tax refund this year. Each has its own advantages and disadvantages, but they all can help guide you down the path to building wealth.
1. Build a Dividend Paying Stock Portfolio
Starting a portfolio of solid dividend paying stocks from blue chip companies is a perfect way to build wealth. Even if your refund is $1,000 you can at least start adding one stock to your portfolio. For example, Kimberly-Clark (KMB) is a well known dividend stock. A $1,000 investment now would buy you about 15 shares. With a current yield of 4.3%, an investor would make about $43 in dividends in the first year. A $5,000 refund invested into the stock would return about $215 in dividends the first year.
If you don’t know where to look for quality dividend stocks, you can start by checking out the list of dividend aristocrats. Companies that are included on this index must be current members of the S&P 500 and have increased their dividend payouts for at least the past 25 years. It is critical to build your portfolio from companies that have historically given their shareholders a raise every year. Kimberly-Clark gave its shareholders a nice raise last year but boosting its dividend by 10%!
Tip – If you want to accelerate building your portfolio, setup a dividend reinvestment plan through your broker to automatically buy additional shares of stock.
2. Invest in Certificates of Deposit
If the stock market is just too risky for you, then there are other investment opportunities available. Certificates of deposit (CD) purchased from federally insured banks can guarantee a return on investment with no chance of losing any money. One major bank, for example, is currently offering a 1.29% APR on a 12-month CD. Invest your $1,000 in a CD and you will earn $12.88 in interest the first year. A $5,000 investment in the same 12-month CD would earn $64.41 the first year.
Because interest rates are so low right now, there are probably more profitable investments out there. However, a certificate of deposit provides you with a secure investment that can never be lost. Plus, once interest rates start to go up your return on investment will rise with them.
Tip – If you have a couple thousand dollars to invest, try building a CD ladder to help increase your rate of return.
3. Fund Peer Loans
A riskier investment than both CDs and dividend stocks are peer to peer loans. Peer lending is a way for individuals like yourself to fund loans for other individuals looking for capital. It cuts out the middle man (banks) and allows borrowers to take out a lower rate loan then they would receive from other lending sources. You, as the lender would receive a higher rate on your investment for funding a portion (or all) of this loan.
Lending Club, one of the more well known peer to peer lending platforms, is currently promoting up to a 9.6% return on investment. Our $1,000 tax refund invested in a 9.6% loan would now return almost $100 in interest.
It is important to note that peer loans are not FDIC insured so this type of investment is much riskier then the first two options. In the event a borrower declares bankruptcy or defaults on their peer loan, you may lose the remaining principal that you funded on the loan. There are a few ways to lower the risks by breaking up your initial investment to fund several loans. For example, your $1,000 could be broken up into 20 loans at $50 each. This tactic is similar to how investors diversify their stock holdings in the market.
Tip – As noted earlier, try to spread your funds out across several peer loans to diversify your investments. Never fully fund a peer loan on your own unless you are 100% sure your money will be safe.
Tax season can be a very stressful time for people. If you are one of those people getting a large refund this year, why not take advantage of this money? Unless you are just getting by on a mortgage or are close to bankruptcy, a lump sum payment like a tax refund can be a great way to build your wealth.
What will you be doing with your tax refund this year?