The average refund for the 2020 tax year was $2,827. While many people treat those refunds as windfalls to be spent on splurges such as vacations or large purchases, paying down debt -- particularly high-interest rate debt -- is a better option. But if you don't have any high-interest rate debt (and you do have sufficient money set aside in an emergency fund), the smartest option for putting your tax refund to good use may be investing it.
Below, I'll look at how much your annual investments of $2,827 could grow over the long term, using a growth stock like Pfizer (PFE -3.85%) as an example.
Image source: Getty Images.
The power of compound growth
Investing $2,827 each year into stock would mean that over the course of 20 years, you'd contribute more than $56,000. And if you were to do so for 30 years, then that amount would total more than $84,000. But it's thanks to compound growth that you could generate much more from your contributions.
And a growth stock like Pfizer is a great option in this example of where to invest. Over the past 10 years, the healthcare stock has generated total returns (including dividends) of approximately 260%, which equates to a compound annual growth rate of 13.67%. If you achieved that rate of return on your portfolio and kept adding the same amount to it each year, here's how it would grow in value.
Chart by author.
In the above chart, the assumption is that you're reinvesting your dividends back into the stock, allowing those payouts to compound over the years as well. (At current share prices, Pfizer's yield is 3.2% -- well above the S&P 500's average yield of 1.3%.)
The key variable to consider, however, is time. The more years that you can contribute, and the longer you can let your assets' growth compound, the greater your potential gains will be. In this hypothetical scenario, for example, in year 20, your portfolio value would be worth around $280,000. But hold on for another 10 years -- and continue to invest steadily -- and it would be worth well over $1 million.
Picking the right investment is key
All the money you invest won't matter if you pick bad stocks that don't increase in value over time. The reason I chose Pfizer for this example is that it has continually been a top business in the healthcare industry, with profit margins that are usually well over 10% -- and sometimes more than 20%.
PFE Profit Margin data by YCharts.
Such strong and profitable businesses are relatively safe investments. Moreover, Pfizer's operations are global, and the company estimates that its treatments reached 1.4 billion patients this past year -- more than one out of every six people on the planet.
Although its COVID-19 vaccine and its oral COVID-19 treatment will give its top line a significant boost this year, to the tune of $54 billion in revenue, Pfizer has been innovating for years, which should give investors confidence about its long-term future.
When in doubt, buy an ETF
If you're not convinced about Pfizer -- or you just don't want to put all your money into one stock -- an exchange-traded fund can also be an excellent option for long-term investors. The Health Care Select Sector SPDR Fund (XLV -0.67%), for instance, holds many healthcare stocks (including Pfizer). Top industry performers such as UnitedHealth Group, Johnson & Johnson, and AbbVie, along with Pfizer, each compose more than 5% of the fund's weight. It contains more than 60 different stocks across the pharmaceutical, healthcare equipment, healthcare services, life sciences, and biotech segments.
And over the past decade, it has (before factoring in fees), provided investors with even better returns than Pfizer, and it has also outperformed the S&P 500:
PFE Total Return Level data by YCharts.
Over the past year, however, Pfizer's 48% return handily outperformed both the S&P 500 (up 13%) and the Health Care Select Sector SPDR ETF (up 11%).
Regardless of which option you choose, if you can invest $2,827 (or whatever amount you can afford) each year for a few decades, you'll thank yourself when it's time to retire. The longer you can stick to making regular and recurring investments, the better off you'll be.
