According to the IRS, the average tax refund this year has been $2,775, just 0.3% higher than last year's total of $2,767. While many people may use that money to pay down bills or end up spending it, if you can afford to do so, it may be most worthwhile to invest those funds. Although tax refunds can fluctuate from one year to the next, if you put aside $2,700 every year, that's the equivalent of saving $225 every month. And you might be surprised how much you can earn from that over the long term.
Below, I'll look at just how much you can make from investing that much into the stock market every year, and why it could be a great way to save for retirement.
Image source: Getty Images.
ETFs are ideal options for long-term growth
One way to increase the likelihood that you will save and invest money is by making it as easy as possible. If every year, when you received a tax refund, you had to go out and analyze which stock(s) to invest in and decide how much to put in each -- that process might be enough to turn you off investing entirely. After all, stock prices can vary wildly, and a stock that was a good buy last year may not be as attractive now.
This is where investing in an exchange-traded fund (ETF) can be beneficial, allowing you to invest into a pool of stocks all at once. It can simplify the decision-making process if you just invest all or a portion of your tax return into a single fund. And since ETFs can contain hundreds of stocks, they won't be as volatile as if you were to invest in a single holding.
Two great options are the SPDR S&P 500 ETF Trust (SPY -0.59%) and the iShares U.S. Healthcare ETF (IYH -0.12%). With the former, you are investing into a fund that attempts to mirror the S&P 500. The latter, meanwhile, can give you more focus on just the healthcare industry as a whole. Some of the top names in that fund are Johnson & Johnson, UnitedHealth Group, and Pfizer. Over the past 10 years, the healthcare ETF has risen more than 338% (including dividends), which is better than both the S&P 500 itself (314%) and the SPDR S&P 500 ETF (310%). There are many other ETFs to choose from, including ones that are even more specialized, but these are two generic examples that could be among the safer long-term options for investors to consider.
How much can you earn from investing in these ETFs?
Both funds have averaged a compound annual growth rate of about 15% in recent years, and so that's the assumed percentage I'll use for the purpose of these calculations. Here's how your portfolio's balance could increase over the years if it were to grow by that amount and you continued to invest $2,700 every year:
Data source: Author's calculations. Chart by author.
At the 10-year mark, your portfolio would be worth more than double what you have contributed at that point. And the longer you continue investing, the greater that delta becomes:
| Year | Total Contribution | Ending Portfolio Balance |
|---|---|---|
| 10 | $27,000 | $63,043 |
| 20 | $54,000 | $318,087 |
| 30 | $81,000 | $1,349,884 |
Data source: Author's calculations.
It's important to remember that these are only estimates and actual returns could vary greatly. Investing right now, with the markets at all-time highs, could mean lower future returns, especially if inflation rates rise in the next few years and that leads to some pullback in stock prices. However, if you are investing over the long term, then you are likely to come out ahead, regardless of the current economic conditions. The only question is how big your returns might be. After all, making money in the stock market isn't difficult, it just requires patience.
The safest, most reliable path to long-term growth
Even if you are a novice investor, picking one of the ETFs listed here can be an easy path to cashing in some great profits by the time you go to retire. Investing in meme stocks, on the other hand, can be fun and exciting, but it can also put your portfolio at significant risk and undo the savings and progress you have made.
If you have savings set aside for a rainy day, then the next time you collect your tax return, consider investing it. It could be the start of a great annual tradition that you thank yourself for years from now.
