An additional disclaimer: This post is not intended as personal financial advice. Before making any substantial financial decision, please seek personal and professional advice from a qualified financial advisor or planner.
The financial year ends in Oz June 30th and whilst I don’t know about you, June through August is a time when I daydream a little. I daydream where to deploy that Golden Injection of Capital that is the tax return. Around 82% of Australians receive some kind of tax return, the average being ~ $2,112AUD ($1580USD; for comparison, the average American return is $2800USD). These are decent chunks of money we’re talking about!
This year, I’ve estimated my return will be around $2,800AUD.
There are several options available to the average tax returnee (is that even a word?). Here is my brief list of deployment strategies that make the cut.
- Pay off debts, especially high interest debt
- Add to your emergency fund (or start one)
- Add to your investment account
- Add to your retirement account
- Save for a specific goal (e.g. new (used) car, home deposit, travel fund)
- Leave it in an interest bearing savings account for a later decision (e.g. talk to a financial advisor or mull it over (educate) yourself for a few months)
The debate whether to pay off debt, increase or start an emergency fund or invest is an ongoing one, and in all honesty, I think the answer is different for everyone and varies with income, savings, life stage, risk aversion and responsibilities.
My go to rule, or what Barbossa might call more of a guideline than an actual rule, is that the deployment of capital must allow you to sleep well at night. Anything that makes you feel more than a little uneasy needs to be crossed off the list.
With my pirate code of capital allocation in mind, I’ve decided to allocate my tax return this year to paying down credit card debt and depositing the remainder in a buffer account.
Why these two allocations? My credit card debt is reasonable but not long ago I wrote how I finally paid it all out, then seem to have proceeded to get re-submerged in them far too easily. I really want to get that in order. When I paid out my credit card debts earlier this year, my primary strategy for avoiding a return to debt was to create a ‘reverse credit fund’. Basically, the idea was to have a small amount to draw down on should I need to, instead of relying on credit (e.g. $2000) and replenishing this fund as if I were making credit card repayments. I never got around to building this fund and ended up spending on credit to service my car and partially pay for holiday expenses.
Below are my views on each of the options above, given my situation. Hopefully mulling them over with me gives you some ideas about how you might allocate your tax return this year too!
Paying down high-interest debt. Two of my credit cards have interest free periods (45 and 55 days) which I take advantage of at times. I’ll be clearing the balance on the ones currently charging interest and reducing my debt burden to below $500AUD so I can pay the final one out quickly. These debts need to go.
Add to an emergency fund. I currently have a little over 4 months net expenses in an emergency fund, and whilst I could add to this fund I’ve chosen to keep the returned tax capital separate for now. If you’re yet to start an emergency fund or have less than $1000 in one, then adding to it might be wise. I want to sleep well at night, and having a few months expenses saved adds peace of mind should I become unemployed or unable to work in the short term, but anything more than 4 months expenses seems to be excessive, at least at the moment.
Investing the funds. I recently closed my investment in Novaport’s Smaller Companies Fund as there is a very reasonable probability I’ll need access to that cash to bridge the gap between University and employment. It would be dangerous to add to my investments at a time when if the markets halved, I’d be financially strained. Nevertheless, after debt reduction and saving an emergency fund, I believe the sooner one starts investing the better. For example, an investment earning 8% p.a. doubles every 9 years, that’s not a bad deployment of capital by any means. You can see my thoughts on the value of starting investment savings early here. A corollary to that piece is that if you might need the money in the short term then keeping the funds in cash is a good choice.
Adding to your retirement fund. There are risks associated with Australian retirement funds that I’m not willing to bear (e.g. legislative: could the Government change the tax rates, levies or age at which one can access their funds in a deleterious way). In general, I think this should only be done if several conditions are met. These include a stable income, adequate emergency funds, no high-interest debts, no need to access the cash until retirement, a belief that the Government won’t make significant changes to the rules surrounding Superannuation and perhaps some kind of tax advantage. I don’t know if the same risks apply for International readers, but I’d imagine it’s quite possible. If one minimises investments in retirement accounts vulnerable to Government policy change, then it’s crucial to be disciplined and create a ‘retirement fund’ outside of Super that you invest reliably in for the rest of your working life.
Saving for a specific goal. Aside from travel, there aren’t any significant specific savings goals I have at present. Once I start working, I’ll be saving for a house deposit, investments, and travel but each of these are currently on ice until I have more certain cashflow.
Leaving the funds in an interest bearing account for a later decision. Being the dreamer I am, I’ve already thought my deployment plan through. But this is my go-to suggestion for people unsure of what to do. If you have a mortgage offset account, that’s an ideal place for the funds to go until you’ve come up with a better alternative.
All of the options above are reasonable deployments of capital. A further option if you have an adequate cash flow, paid off debts, established an emergency fund and are meeting financial responsibilities well, is giving a portion to a charity. Whilst this is more of a values-call than something that will offer a financial return it can be very worthwhile if the charity allocates the funds they receive wisely. Whatever you choose, enjoy thinking it through and if needed, seek professional advice.
Where do you decide to deploy your tax return? What guidelines do you follow when deciding how to allocate tax or other windfalls? Have your own thoughts…add them in the comments section below!