Financial professionals at LearnVest say when you receive a windfall, you should pay yourself 20 percent and put the rest somewhere that will better your financial situation, such as paying down debt, padding an emergency fund or investing for your retirement.
So after you’ve purchased one pair of shoes or gone out to eat one dinner, use the rest toward one of the options below, and set yourself up for a great 2013.
1. Start or add to an emergency fund. Though financial experts Dave Ramsey and Suze Orman disagree on how many months’ income you should have stashed away in an emergency fund, the universal takeaway is that you should have something saved in case you lose your job, your car breaks down or unexpected bills arrive. If you have debt, the absolute minimum you should have in your savings is $1,000, according to Dave Ramsey, though six months’ worth of living expenses is ideal. That means you should have enough money for your rent, bills, gas and food (groceries, not dining out), all pared down to the least possible amount (so go to basic cable or cut cable entirely). The six-to-eight-months amount may take you awhile to save, so your income tax refund will add a lot of money at one time, possibly incenting you to eventually gather the rest.
2. Buy something you really need. If you need to replace your tires within the next few months, stash your tax refund in a savings account until then or go ahead and buy them now. Other items that fall into this category include any surgery, dental work or wardrobe necessities (such as work shoes or a warm coat). Are you moving soon? Set aside money to pay for apartment deposits, utility hook-up fees, your first month’s rent or moving expenses. Find your personal budget strategy and learn which expenses to plan for when you move.
3. Start or add to a retirement account. Think just because you’re in your 20s, you don’t need to start a retirement account? Think again – the younger you are, the more time is on your side. When you’re young, you can invest less and utilize compounding interest to avoid having to save larger amounts when you’re older. So sign up for that 401(k), a Roth IRA or at the very least, a high-yield savings account, and begin putting money into it with every paycheck. Ten percent is ideal, but do put in the amount the company matches, if applicable.
4. Pay off debt. Debt can be divided into two categories: good and bad. Good debt is anything with a low interest rate that is on a typically non-depreciating asset, such as student loans or a mortgage. Bad debt is consumer debt, debt you acquired buying things you couldn’t afford, such as credit card debt. When you’re consumed by debt, it’s difficult to meet your other financial needs, such as saving for retirement. Use your income tax refund to make a big impact toward putting you in the black.
5. Start a vacation fund. If you already have an emergency fund, don’t have credit card debt and don’t need major automotive work, use the money to start a vacation fund. To figure out what you need, add up your vacation expenses (lodging, transportation, food, shopping and excursions) for the past three years and divide it by three to get an average yearly vacation expense. Normally, you’d divide that number by 12 and save that amount each month, but with a jump-start from your income tax return, you’ll have far less to save on having fun.