Source: 401kcalculator.org via flickr
What would you do if you had an extra $1,000 right now? With tax season in full swing, many people will soon find themselves with extra cash, so it might be a great time to start thinking about the best ways to use it.
We asked four of our writers to tell us the smartest things they could think of to do with an extra $1,000, and to explain why each one is so "smart." Here's what they had to say.
Matt Frankel: Paying down any high-interest debt (such as credit cards) is the best use of an extra $1,000 -- even better than investing it. This can save you lots of money down the road, and can set you up for success when you do have extra money to invest.
For example, let's say you owe $1,000 in credit card debt at 18% interest. This means that it costs you $180 per year just to owe the credit card company that money. According to a credit card payoff calculator, if your minimum payment is $25 per month, it will take five years to pay off the balance and cost you a total of $1,500.
Even if you're an excellent investor, the best return you can consistently hope to earn from your investments would be about 12% per year. So, if you invested your extra $1,000 instead of paying down your debt, you might make $120 in profit for the year. Meanwhile, you'll have paid about $180 in credit card interest during that period if your balance stayed constant. In other words, you actually lose money by investing while carrying high-interest debt.
Dan Caplinger: Those who find themselves with an unexpected $1,000 often figure there's no point in using it to start investing, because there's not enough to justify the hassle of opening a brokerage account and paying even modest commissions. Fortunately, though, many companies allow you to make direct investments in shares of stock and have dividends automatically reinvested into additional shares.
Known as direct purchase or dividend reinvestment plans, these programs give small investors access to stocks without having to have a brokerage account. Different plans have different features and costs, and if you have only $1,000 or less to invest, it's important not to choose high-fee direct purchase plans that would eat away at the value of your investment. But with the ability to make additional investments either automatically through periodic withdrawals from your bank account or manually whenever you want, these plans are a great way to build a diversified portfolio of desirable stocks without forcing you to pay more in up-front costs than you actually end up investing. To learn more about companies that offer direct stock purchase and dividend reinvestment plans, this list of stocks at Computershare's investor center website lists minimum investments and other features for hundreds of companies.
Todd Campbell: An extra $1,000 is a good problem to have, but not if you're planning a trip to the Apple Store (AAPL 2.21%). Instead of spending that money on a new phone or tablet that will lose value, perhaps a better decision would be to help your kids learn about money and markets.
One way to do this is by opening an UTMA account, a type of custodial account that allows you to transfer money to minors. Once the account is open, you can buy or sell mutual funds, stocks, or other investments, and when your child is old enough, you can get him or her involved too! Doing so can teach valuable investing lessons like how to differentiate between a fad (silly bands, anyone?) and a disruptive technology (Netflix (NFLX 0.17%), perhaps?).
A small amount of money in an UTMA account is a great way to get your child excited about investing; however, if your goal is college savings, a 529 plan might be a better bet because UTMA accounts can reduce financial aid. Also, UTMA gifts are irrevocable. That means the money becomes theirs, not yours. They won't get their hands on the money until they're older -- usually 18 or 21, depending on the state you live in -- so you'll remain in control of how the money is invested, but once they reach that age they can spend the money any way they want.
Dan Dzombak: One smart thing you can do with $1,000 right now is contribute to a 401(k) or IRA.
It is always tempting to spend such a windfall rather than save it. However, by contributing to a retirement account, not only do you set yourself up for increased earnings for years to come, but you also potentially get a tax deduction that can lower your tax bill this year or next.
With a 401(k), while it is too late to get a tax deduction for 2014's taxes, the employer match many employers offer can make a 401(k) the best place for your retirement savings. For example, if your employer matches your contributions completely, that's the same as a 100% return. Assuming an average stock market return of 8%, similarly doubling your money in an IRA would likely take a decade. All 401(k) plans vary, but it can pay to educate yourself on your employer's plan.
If you want a tax deduction for tax-year 2014, you can contribute up to $5,500, or $6,500 if over age 50, to an IRA up until tax day, April 15.
Using a windfall to contribute to retirement accounts offers the added bonus of a tax deduction, making your windfall go further, and your investments can grow tax free over time, setting your future self up for a better retirement.
