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How should I spend my tax refund?
DFA reader C.L. Haddon asked:
Hi, Matt – I am receiving approximately $1,000 back from taxes this year and want to make the best decision as to how to use it. Should I pay down credit card debt, payoff a small installment loan or put it in savings for an emergency fund? I have a personal loan of $1075 at 18%, a credit card with a balance of $3,500 at 14.99%, a credit card with a $1,000 balance at 0% (until June, 2010), another credit card with $4,500 at 9.99%, and lastly a Sears card with a balance of $650 at 22%. I live on SS and income from a part-time job. I commonly have some difficulty making ends each month, primarily due to one-time events like medical co-pays, prescription co-pays, auto repairs, etc. I am 65, female, and the sole wage earner. What is the best use of the $1,000 refund?
Always pay yourself first
Hi CL, thank you for your question.
If I were in your situation there would be no question as to what I would do with the $1,000 tax refund – I would start an emergency fund and save the entire amount as a buffer against the “one-time events” you mention.
Here are some other ways you can a turn your financial situation around:
Increase your cash flow
The reason you have credit card debt is because it sounds as if you are living pay-check-to-paycheck. You need to increase your cash flow. This does not mean that you have to increase your income (although that is a solid idea if it is possible) instead you may want to focus on decreasing your expenses so you have more money available for savings at the end of each month.
Other ways to increase your cash flow:
- Create and live by a written monthly budget
- Implement the cash envelope system.
Doing these two things help make my wife and I much more efficient in our spending. Now we tell our money where to go instead of wondering where it went.
After seeing your income sources and your debt amounts I am assuming that a good portion of your cash flow goes toward debt repayment; but are their any expenses you could cut, at least for awhile?
Some possible expenses to cut:
- Cable TV – we just plain do not need television, if cutting this helps you get on your feet financially, then cut it.
- Cell phone – cut back your plan or consider getting a land line with limited or no long-distance service.
- Eating out – we were spending $6,000/year on dining out and have since all but eliminated this expense.
- Unnecessary groceries – pop, snacks, etc. Instead focus on beans and buying in bulk, here are a few ways to save money on groceries.
Pay down debt
Another reason you have no cash flow is because so much of your monthly income is going toward the interest on your debt. I am willing to bet that your debt stacked up slowly over time as one emergency after another hit your pocketbook when you were without savings. If you have that $1,000 emergency fund then you have some solid ground to stand on next time something comes up.
Build your savings
Beyond creating your emergency fund you should also continue to fund it each month, even if you can only do so a little at a time. I have debt too, so I cannot save everything I make. What I have decided to do is attribute 75% of my available cash flow to debt repayment and 25% toward savings. This allows me to pay down my debt and save at the same time – I call it the 75/25 method.
What do you think?
Do you think that C.L. should use her $1,000 to start an emergency fund, pay down some of her debt, or toward something else entirely?
If you need personal finance advice… ask Matt Jabs.
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