A few weeks ago some people were scrambling to finish paying their taxes (not you, you finished yours a while ago, right?). About now a slow trickle of the magical “tax refunds” are being disbursed to people around the United States. “Wow, this is cool!” they will say. “I just got $3,000, time to go buy that (fill in the blank) I’ve always wanted but have been too irresponsible with my money to save up for!” “Never mind that the responsible thing to do would be to pay down my (fill in the blank with student loans, mortgage or credit card debt), I want new cool stuff that will bring me temporary and hollow happiness!”
I know none of the people reading this are that person, but there are a lot of people who think exactly this way.
If you pay money to the government in the form of income taxes, your tax refund should be as close to zero as you can make it. Unless you’re cool with the government borrowing the money you’ve earned interest-free for months at a time, you should do some math to figure out how many deductions you should claim to ensure you’re contributing as much as you should, but no more. There are a lot of good tax calculators out there you can find with a quick Google search to help you do this. Then it’s a simple matter of reaching out to your HR department and having them adjust your withholdings.
There, now you’re accumulating that $3,000 as you earn it, providing you with the awesome ability to put that money to work right away. If you do, you’ll now have a “tax return” of $3,116.22 for the year (assuming a 7% rate-of-return invested monthly throughout the year). That’s not too bad for completing a few easy tasks! You’re welcome.
The question for this week is, what do you do when a large and somewhat unexpected chunk of money comes your way? This question came about a few weeks ago when, on one fateful day, I checked my mailbox and found not one, but TWO pieces of mail notifying me of upcoming drops of money into my financial bucket.
The first informed me that it was time for the annual “University of Michigan Family Economics Study” survey. This is a fantastic study that measures household financial health through generations. I was fortunate enough to marry into this study. For my trouble (and detailed information about my financial situation) I will be compensated with $75! Not bad for a simple phone conversation.
The second bit of mail told me that I was a part of a class-action law suit because a past employer had been doing some shady things and that now, five years later, I was being made whole. I had to send a post-card to opt-in to the suit. Once a certain date has passed I will be mailed a check for my portion of the award. The expected sum: $125. Not exactly enough to retire on, but I had written that money off a long time ago and I will welcome it to my bank account gladly and with open arms!
One day, two pieces of mail, $200.
The individuals in our tax example above would immediately formulate intricate plans for their windfall. A new thing for the house or car, a fancy meal or something else equally unnecessary. Being exceptionally boring and predictable my windfalls will go immediately to the category of my budget titled “Income: to be budgeted.” My prediction is that, once I’ve reconciled my budget for whichever month I receive this money, these modest sums will find their way to the budget category “Extra money towards student loans.”
How lame am I? Being exceptionally lame, I did some math to find out exactly how lame I am. Over the next 5 years, my decision to use this money to pay off student loans will earn me $83.53 in interest. Now, admittedly $83.53 isn’t a lot of money. However, there is GREAT power in making these decisions consistently. Each time we make a small decision to reinvest the money we receive rather than spend it on whatever thing we see that we want, we are moving ourselves closer to reaching our financial goals, whether that be paying off student loans, a mortgage, credit card debt, or financial independence (really, these things are related and mastering each will improve your life dramatically).
But, what about our person who received $3,000 in the example above, what would happen if they invested their money? After five years they would be $1,252.88 closer to financial independence. That’s real money.
Being wise with windfalls has become a habit for us because we are not emotionally connected with our money. Our happiness is not dependent upon money. We are not living in a state of “scarcity” common among people at all income levels. We have enough, so we are not constantly hoping for more money to purchase some new “thing.” That power over things will give you the ability to manage windfalls wisely.