What are you going to do with the money Uncle Sam is so thoughtfully sending you?
Many people treat tax refunds as "found money" and use them to splurge: a new TV, a new bike, maybe a down payment on a new car. That's not awful. I'm all in favor of stimulating the economy, and I'd rather see it done with cash than with debt.
But refunds aren't really found money. They are nothing more than the return of an interest-free loan you gave to the government. That money arguably should have been left to increase your net take-home pay each month.
So what are you going to do with yours?
How to maximize your refund
Let's get this out of the way first: If you've been carrying a credit card balance, paying that down is likely the best use of your refund. If you consider the interest payments you'll save by not carrying that balance any longer, the "return" on such a payment is likely to be greater than that of most investments.
You don't want to tangle with the card companies if you get behind on your payments. You might think that the Credit Card Reform Act has curbed the worst of the industry's abuses, but I'm skeptical. With three of the biggest issuers, Bank of America
No credit card balances? Here's a great opportunity.
If you're not carrying a credit card balance, having some cash stashed in a savings account or a money market mutual fund isn't a bad idea. But here's another thought: Why not take that refund and make all or part of your 2010 IRA contribution right now?
Think about it. Stocks have rebounded significantly since the 2009 market lows, but the economic recovery is just starting. The best companies are likely to see continued growth for a while as spending increases around the world. Buying those stocks now -- instead of next spring -- is likely to be worth your while in the long term.
Let history be your guide
Seven years ago, the last economic recovery was really starting to gather steam -- not unlike our recovery is (hopefully) doing now. Let's make some hypothetical, retroactive investments in dividend stocks, good ones that have increased their dividends every year for a long time. These are exactly the sort of stocks that make great IRA investments; you get the power of reinvested dividends over time, without the tax hassles.
I took a look at what we would have earned if we'd bought $1,000 worth of each of these stocks for our IRAs in April 2003, rather than waiting until the last minute and buying shares at tax time in 2004:
(NYSE: MCD)is one of those companies that does well during recessions as well as during good times. It's looked great over both periods, but you'd still have lost out by waiting. A $1,000 investment on April 15, 2003, would be worth about $5,220 now, versus the $3,026 you'd have if you'd waited until the same date the following year.
(NYSE: EMR)is a gritty industrial power management company that helps manufacturing plants of all kinds run more efficiently, electrically speaking. Another distinction of note to us is that it has raised its dividend every year for a whopping 53 years straight. Emerson is a great company to consider buying now, and if you'd bought $1,000 worth on tax day in 2003 you'd have about $2,600 now, a $600 bonus over what you'd have if you'd waited a year.
- Medical technology specialist Becton, Dickinson is another company with a long tradition – more than 25 years -- of raising dividends every year. With a five-star CAPS rating, it's worth considering now. If you'd bought it in 2003, you'd have almost $2,700, a $900 advantage over the same investment made in 2004.
- Want one more? Check out Chubb. This property-and-casualty insurer is another dividend-raising perennial, and another CAPS five-star darling. That 2003 investment would have you sitting pretty with about $2,550 now, an $800 or so advantage over those who waited until 2004.
You see where I've gone with this? Waiting can be expensive, especially during an economic recovery. When you get your tax refund, consider funding your IRA and putting that money to work for you in some high-quality dividend stocks right now. Stock market averages may go up and down as the economy continues to sort itself out, but the best companies -- like the ones I've mentioned -- are likely to see solid gains as the recovery continues to gain traction.
If you don't have an IRA account, it's easier than ever to open one with a discount broker; the fees are minimal and everything is available online, 24 hours a day. Just hop over to the Fool's excellent (and free) IRA Center, where you'll learn about the different kinds of IRAs and the easy ways to open one. It only takes a few minutes to get started.
The economy may be recovering, but you still need to be careful. Amanda Kish explains the coming investment trend you need to avoid.
Fool contributor John Rosevear has no position in the companies mentioned. Emerson Electric is a Motley Fool Income Investor pick. You can try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.
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