Thanks, compound interest: 20 tax refunds later, now you have $127,000
A tax refund, any tax refund, is always exciting. But you know what will give you an even bigger rush? Making those funds multiply like bunnies and ending up with like $127,000 in two decades. Still thinking it’s more enjoyable to blow your annual refund on season tickets to the amusement park or a new dryer or your annual springtime splurge? Check out this method. If it doesn’t change your mind, at least you’ll know why other people have lots more money than you 20 years from now:
$127K begins with one refund
It’s not dramatic or even particularly complicated. The “secret” to turning tax returns into lots more money is putting the money into an investment where you can’t draw it out next time there’s a sale at TJ Maxx. To understand why there’s such a huge difference between using your refund for vacation or investing it, you first have to understand how compound interest works. If you’re thinking, “Wouldn’t $1,000 times 20 years work out to $20,000?” you’re thinking of money you would otherwise be stash under the mattress. You know, the funds that stay the same no matter what happens with the market or your personal situation.
If you make an investment, though, that money not only earns annual interest, but the interest is added to the base investment amount each year. So if you were making even a lowly 3% interest on that investment, it would pay $30 the first year. Going into the second year, that base investment is $1,030, to which you add the following year’s tax refund. So your money doesn’t just add up, it compounds because you are earning interest on your interest.
If you have experience with a credit card that charges annual interest and you carry a balance, you already know how fast interest compounds. But this uses that harsh system to your advantage. Every time the interest gets tacked on to the total, it’s savings, not something you owe.
And so it grows
Even with all the brouhaha about tax returns being lower in 2019, the average American tax return is still somewhere around $2,700. If yours is in that category, just one year of paying it into an account that earns 6% could up the total to almost $10,000 in 20 years. To be more precise, if you round the figure up to $3,000 you’d have $9,620 two decades hence even if you never added to the initial investment. (Naturally, you can’t take from the original investment, either.)
As for that lavish $127,00 figure, that’s what would happen if you also added a $3,000 tax refund each year starting with this one. By combining compound interest and fresh investments, you would end up with $126,600 in 20 years.
You may need a mental shift, too
Part of what makes it so appealing to indulge yourself when that return hits your direct deposit is a mistaken idea that it’s a random favor from the government. But it’s not; it’s money you or your spouse worked hard for that the government has been holding interest-free due to your withholding specifications. “It’s easy to feel like your tax refund is free money, but while you may have forgotten about it, it’s definitely something that you’ve earned,” Cynthia Flannigan, a certified financial planner at MainStreet Financial Planning told Bankrate. “So, you should spend it with the purpose to achieve your goals.”
It’s a lot more difficult to justify blowing $127,000 in 20 years than it is to splurge with the once-a-year $3,000 check, but you can take away any temptation by mapping out a plan for the eventual spending as well as the current investing.