Millions of Americans sit down every year to figure out where they stand with their taxes. While 2021 wasn’t the simplest of tax years to say the least, tax refunds are winging their way into bank accounts nationwide. So what should you do with your returned cash?
Axos SVP Tracy Gallman sat down with Meeder Investment CEO and President Bob Meeder to talk about some of the smart strategies to consider as you decide how to use your refund to boost your current investment strategy.
Q | Tracy Gallman
Tracy Gallman: Obviously, the American Rescue Plan and elements of that legislation, like the Child Tax Credit, are making 2021 returns more complicated for many and making refunds much tougher to predict. With that kind of extra uncertainty, what are some smart ways people can use their returns wisely to bolster their investment?
A | Bob Meeder
Bob Meeder: The first thing that an investor should do if they get a tax refund is pay off credit card balances and any high interest rate debts. The average interest rate on a credit card is around 18%. Once debt is reduced, then invest refund dollars into mutual funds that meet their long-term objectives.
Q | Tracy Gallman
TG: Do you think that after they've paid down debt, they should consider cash and investments or just investments?
A | Bob Meeder
BM: I always believe an investor should have a rainy-day fund with three to six months of living expenses. Have that in a conservative investment so that if something were to occur, they could draw on that without any market risk to those assets. After a cushion has been established, then they should have a long-term investment in place for themselves.
Q | Tracy Gallman
TG: Let's talk about inflation. This is certainly on everybody's mind these days with diminished buying power. How does putting your tax refund into your portfolio better protect your money?
A | Bob Meeder
BM: Over the long haul, we believe a prudent way to hedge money against inflation is to invest in the stock market. Even though we've seen volatility in the stock market, over the long haul, we believe the stock market will provide a higher real rate of return. The real rate of return is an investment return minus inflation. Typically, money markets don't provide a significant real rate of return as an average. Yield is similar to inflation, so the real rate of return is zero. Over the long haul, investing in the stock market may potentially result in a higher real rate of return than alternatives.
Q | Tracy Gallman
Tracy Gallman: With inflation already climbing up over 7% and possibly higher, what type of return in the stock market would even keep a client equal?
A | Bob Meeder
Bob Meeder: We’ve got a study on this over a longer term timeframe of 10 to 15 years. When you look at almost every 10-year period, the stock market has provided a real rate of return greater than inflation. When you factor in dividends and the return of the stock market, it averages about a 5% real rate of return, meaning after inflation. That's significant as when compared to bonds, which are about 1 to 1.5%. The stock market is your best bet over the long term.
Q | Tracy Gallman
Tracy Gallman: For those clients who are concerned about the risk and the volatility and uncertainty, perhaps a solution is to take a little more balanced approach. Keeping some money in a rainy day fund combined with an investment rather than just the rainy day fund.
A | Bob Meeder
Bob Meeder: The more moderate type of investor could do a dollar-cost averaging approach. They could just do a little bit of investing into an investment portfolio, a little amount each month. That will enable them to buy at some lower prices over time as the market fluctuates.
And if they're more conservative or moderate, they should look at more balanced types of investments. So yeah, if a person really understands their risk tolerance, they should not have an aggressive portfolio. As soon as they're more aggressive than they should be, and the market turns down, they'll panic and sell, which is the wrong thing to do. So they’ve got to get that right risk profile of their investments to match their risk tolerance.
Q | Tracy Gallman
Tracy Gallman: As people think about their refund, perhaps retirement will come to mind. Maybe they're a newer investor who hasn't set up a traditional or Roth Individual Retirement Account (IRA). Or perhaps a refund check will be used as the annual IRA contribution for someone who’s already invested. What should investors be thinking about when it comes to their IRAs?
A | Bob Meeder
Bob Meeder: If they can take a refund and put money away in an IRA versus just a regular savings account, that would be the best long term decision. That IRA money can grow on a tax-deferred basis. They’ve got to be able to say, I will put this money away and it's going to stay there and I'm not going to need to touch it. If they can't say that, then the IRA approach is probably not the best approach. But there's the traditional IRA, which allows you to use the amount that you put in to reduce that amount from your taxes. Then there's the Roth that allows you to put in after-tax dollars. If you max out your traditional IRA and you have more that you want to put in, you can put those after-tax dollars in a Roth IRA to let the money grow.
Q | Tracy Gallman
Tracy Gallman: What about setting up IRAs for kids and grandchildren to help them pay for college and start a nest egg? Is that another good use of tax refund money?
A | Bob Meeder
Bob Meeder: Absolutely. For those people who have that extra cash so they can make those contributions to their kids or grandchildren, that's a great idea. And they could also look at 529 plans. So IRAs and 529 college saving plans are great vehicles for that opportunity.
Q | Tracy Gallman
Tracy Gallman: There's so much volatility in the market. How smart is it to put a tax refund into an account in the form of cash so you're immediately ready to act and buy in it if a premium stock has a bad day?
A | Bob Meeder
Bob Meeder: First of all, I think you should look to have a diversified portfolio. If people buy just a few stocks, they can hit more home runs that way. But if those stocks don't work out, they're more vulnerable on the downside. So that's why I think having a diversified portfolio is the best solution. If the investor has a long-term timeframe, then putting the money to work right away isn’t a bad idea. But if they're uncomfortable doing that, they could use a dollar-cost averaging approach instead.
Q | Tracy Gallman
Tracy Gallman: Within Axos Invest, we have access to mutual funds for any investor, many at low entry points. I think some of your own Meeder mutual funds have been tracking at about $9 or so per share. So even if your tax refund is $200, maybe $2,000, getting into a diversified investment vehicle like a mutual fund is an option, right?
A | Bob Meeder
Bob Meeder: Absolutely. And again, build up that rainy day savings plan first. Then once that's done, invest as much as you can consistently over time and stick to that plan. It's amazing what one can accumulate over time. And it doesn't have to be a large amount of money. If they just do it consistently and have a disciplined savings approach, they're going to be able to accumulate significant dollars. And then if they can, they should stick to their investment plan.
