An interesting comment on a recent post caught my attention. In response to my suggestions for things to do with a tax refund, Ross wrote,
“Paying off any high interest debt will save you money in the long run, but it can be pretty tempting to buy something frivolous with the money, especially if you weren’t expecting it.
I feel completely different about the money that I’ve worked really hard for, than something like a refund that I wasn’t counting on. I really want to buy an Ipad, but i’m going to do my best to resist that urge.”
I can relate to Ross’ comment, and wondered if others shared our reservations to frivolously spend money we worked to earn, but feel more temptation to spend money we receive unexpectedly. Of course, one could make the argument that a tax refund is simply a return of money you have already earned and overpaid (assuming you paid taxes at all). In that sense, it is a little different than inheriting money or lottery winnings, etc.
Back to the original idea. Many times financial planning types suggest taking 10% of an inheritance received, or some other type of windfall, and doing something fun with the money. Take a vacation to visit a place you’ve always dreamed of seeing. Buy something of your heart’s desire, even if it isn’t very practical.
I generally think that is good advice, but only if you stop at 10% of the windfall amount. The problem is, many who find themselves on the receiving end of a windfall allow it to change their lifestyle. The expensive, once-in-a-lifetime luxury vacation becomes a once-a-year expense that eventually drains savings accounts and can lead to the accumulation of debt.
It also begs the question: Is it easier to spend money you didn’t have to work for? After all, when you apply a real hourly wage concept to your earnings, it may not be worth X amount of hours worked to pay for that trip to Tahiti.
There are some who would scoff at the very idea of spending any percentage of the money frivolously. I can understand that argument, too. After all, there are plenty of things most households could do with the money to better prepare themselves financially, such as.
- Getting out of credit card debt
- Eliminating some or all of your mortgage balance
- Setting aside a one-year emergency fund
- Setting up sinking funds for known future financial events such as insurance renewals, tax payments, annual Christmas shopping, etc.
- Investing for retirement, or future college expenses for kids
- Preparing an emergency stockpile of food, water and basic household goods
In an effort to maintain some balance I would probably do a little of both. I would spend a small portion of the windfall on something I really wanted, but I would lean heavily towards investing the money into something that would continue to provide a return long into the future.
That might mean paying off any consumer debt I owed, or dropping some money into a few quality dividend stocks that would spin off income for years to come. Better yet, it might make sense to eliminate a chunk of our mortgage. That would be like getting an immediate 5% return on the money through saved interest.
One last option would be to do nothing. Just let the money sit in a money market account safely drawing a small amount of interest. We live in an era where people are encouraged to be doing something all the time with their money – actively investing it, monitoring it, counting it, etc. However, often the best move is to simply do nothing.