Pay Off High-Interest Credit Card Debt
Paying off high-interest credit card debt should be your first “investment,” said Cynthia Meyer, a certified financial planner. The return on your money is equal to the interest rate, plus it’s guaranteed and it’s risk-free. Think about whether your return will be better used to pay off credit debt or other debt. Interest rates on both federal student loans and mortgages are, on average, less than 10%, and pre-retirees might want to consider paying off their mortgage before they retire. But paying down the debt that accrues the most interest would make the most sense because it would reduce your overall payments.
Invest Against Future Expenses and Emergencies
“The next question to ask is: Do you have a nice emergency fund?” Meyer said. Ideally, you should save three to six months of living expenses in fairly liquid savings, but anything is better than nothing. Stowing away your tax refund could save you from a world of hurt if you don’t have an emergency fund yet. Having that amount of cash stashed in a savings account means you don’t have to put a new transmission or unexpected medical bill on a credit card. Returns on savings accounts are minimal, but an emergency fund’s job is to be there when you need it.
Meet the Match on Your Workplace Retirement
Taking full advantage of any employer-matching dollars offered in a retirement plan can also be a good idea, depending on your situation. Think about increasing the amount you’re contributing to your 401(k) or 403(b). Aim to do both if you have credit card debt to pay off and/or need to save for retirement. Tim Maurer, a financial adviser and author of Simple Money, said one way to free up additional funds for this (or any of the other options on this list) is to decrease your withholding. Just make sure to increase your retirement contributions simultaneously so that you don’t squander the additional dollars in your paycheck, and that your withholding will still cover the taxes you might owe at filing time.
Fund an HSA
You can park—or even better, invest—your dollars in a Health Savings Account (HSA) if you have a high-deductible health plan. HSAs are triple tax-free: Money goes in pre-tax via a paycheck deduction (or, if you put it in yourself, it’s tax-deductible). It grows tax-free, and it’s not taxed upon withdrawal as long as you use it to pay for medical expenses. Passing money you use in the short-term through the account saves you roughly 25% on all your medical costs. You can also invest the money in the account and allow it to grow. Withdrawals that aren’t used for health care are treated just like 401(k) withdrawals once you reach age 65. They’re taxed at your income tax rate at that time. “If you haven’t maxed out your HSA contributions for the year, you can increase your payroll contribution and invest it in a broad stock market fund," Meyer said. “It’s even better than a Roth IRA because it’s pre-tax and tax-free growth.”
Contribute to an IRA
An IRA is the next step on the road to retirement readiness if you’re already meeting the match on your workplace retirement plan (or you don’t have one). You’ll receive an upfront tax deduction on the money you put into a traditional IRA. It grows tax-deferred, but you pay income tax when you begin taking withdrawals, which you can do starting at age 59 1/2 and must do at age 72. There’s no tax deduction at the time you make contributions to a Roth IRA, but withdrawals are tax-free when you tap the account in retirement. “The Roth [IRA] generally makes sense if you think you’re going to be in the same tax bracket or higher in retirement,” Meyer said. There are also no required withdrawals from a Roth. You can pass the funds to your heirs, and there’s more flexibility. You can withdraw the money without penalty to pay for a child’s college in many cases, or to pay off your home.
Invest in the Stock Market
Consider purchasing stocks or mutual funds if you have your retirement funding squared away, and you’d like to do something with your refund that has the potential to give you back more than you put in, The market has historically delivered better returns than savings accounts and Treasury bonds, but the market can be volatile. Returns are never guaranteed. Trying to time the market is risky, and stock prices can fluctuate. Most financial advisors recommend against investing in the stock market when you’re saving for short-term goals, but they do recommend investing when you’re saving for long-term goals like retirement. You can invest in individual stocks or mutual funds through a broker or a robo-advisor. Mutual funds are bundles of stocks. Robo-advisors offer low-cost investing options for do-it-yourself investors. Keep in mind that your investments are not protected by the Federal Deposit Insurance Corporation (FDIC) like checking and savings accounts are. You could lose money if the stock market drops.
Fund College
Parents who are looking to invest in their child’s future education might want to consider a 529 college savings plan. Similar to a Roth IRA, you contribute after-tax money and your dollars grow tax-free. You won’t owe taxes as long as you use the money for education. You may even get a tax break for your contributions in some states. As much as you may want to use all your extra cash to invest in your child’s education, Maurer recommends making sure your retirement plan is in place first. “You cannot put your long-term financial security at risk for the sake of your children’s college,” Maurer said. “If all of the other boxes are checked for long-term retirement planning, then, by all means, utilize a 529 savings plan.”
Make a Donation
Another way to invest is by making a charitable contribution. You can manage your donations like you would your investment portfolio. But you have to focus less on the charities that make you feel good and more on the ones that do good if you want your money to have the greatest returns or the biggest impact. Ask the charity’s representative questions such as, “For every dollar, how do you spend it?” and “How is the world changing because of your charity?” before you donate. Many charitable organizations are worth considering. You can also use a third-party nonprofit reviewer to research a few that you’re interested in before you pick the one with the best impact.
