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Growing Your Tax Refund

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Growing RefundsThe average tax refund for 2009 is around $3036, up over 10% on 2008 returns. It’s a pretty sizable sum when you think about it. It’s a really nice vacation, a good bit of a mortgage payment, and your credit card debt’s worst nightmare. If, however, you’re more of a saver than a spender, you might be curious how large that amount can really be.

Ever wonder how much $3036 would be in 5 years if it were in a certificate of deposit? A Treasury bond? How about invested in stocks? What if you just left it in cash? What about ten years? Twenty? Forty? Let’s find out.

1 Year

  • CD (@1.54% APY): $3,082.75
  • Treasury (@0.40% APY): $3,048.14
  • Stocks (@9.00% APY): $3,309.24
  • Cash (@0.00% APY): $3,036.00

5 Years

  • CD (@3.00% APY): $3,519.56
  • Treasury (@2.55% APY): $3,443.34
  • Stocks (@9.00% APY): $4,671.26
  • Cash (@0.00% APY): $3,036.00

10 Years

  • CD (@3.00% APY): $4,080.13
  • Treasury (@3.81% APY): $4,412.59
  • Stocks (@9.00% APY): $7,187.32
  • Cash (@0.00% APY): $3,036.00

30 Years

  • CD (@3.00% APY): $7,369.17
  • Treasury (@4.68% APY): $11,973.28
  • Stocks (@9.00% APY): $40,280.67
  • Cash (@0.00% APY): $3,036.00

The point of this post isn’t to say that one “investment” is better than another, but outline how seemingly small differences can result in big differences if you throw a few decades in the mix. I think we all intuitively understand that but unless you see the numbers, it’s not clear how large those differences are.

Data Source

For CD rates we turn to our table of best CD rates (for periods beyond 5 years, we simply used the 5 year rate). For Treasury bonds, we relied on Bloomberg’s U.S. Treasuries data. For Stocks we used the classic 9% rule of thumb rate.

(Photo: jamesjordan)

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29 Responses to “Growing Your Tax Refund”

  1. DIY Investor says:

    Nice post. Worth emphasizing that most advisors (myself included) recommend not investing in the stock market if money is needed within 5 years. The 9% rule-of-thumb is an average annualized return. For any given year stocks can be up or down by a lot more.
    The message of the calculations is that younger people should put more in stocks as long as they can stand the volatilty. It is even more forceful when taxes are taken into account.

  2. Of course, the best situation to be in is getting a $0 refund on your taxes. It means you didn’t give Uncle Sam an interest free loan and were able to invest your money immediately, which would help it compound faster. But it is good to illustrate for young people the impact of compounding at higher rates of return.

    • This is exactly what I was thinking. If you get that more money in your paychecks, you can save that extra money and earn better returns. The problem is that most people don’t have the self control to simply save that money…

      • cubiclegeoff says:

        This is why the “word pays” tax credit we had this past year was put into your normal paycheck, rather than being a part of your tax return, people would be more likely to spend it.

    • echidnina says:

      Exactly! If you can put that money away yourself, and resist spending it, it gives that money even more time to “grow”.

  3. Nine per cent from stocks?

    Reality check suggested.

    Regards

    • Anthony says:

      Everyone makes comments like this one. But 9% return is realistic over a 25-year or longer timespan.

      • rbatt says:

        It just doesn’t seem realistic to me. I tend to be more pessimistic with my stock market projections.

        • billsnider says:

          You have to think about it like kids.

          The average stock market return is 10%.

          It is like having the average family of 2.5 kids. That is the average, but you will never see it in one family (or 10% in any one stock return year).

          Bill Snider

    • cubiclegeoff says:

      Considering some finance “gurus” use 10% or 11%+ for stock returns, 9% isn’t a bad estimate to have. Sure, the past 10 years didn’t come close, but that doesn’t mean it can’t happen.

      • Ryan says:

        I read an article once that dissected the whole 9% return topic. From my terrible memory, it looked back over a 25 year span and found that if you missed something like 5 days in that 25 year span you would have made no money or something like that.

        Basically, averaged over a long span, the real returns were only found from a few instances.

  4. cubiclegeoff says:

    I like how you kept cash in there at a 0% return. I wonder if after 30 years it would be a -100% return because you could assume the can that the money was in was lost, or the mattress was thrown out.

    • billsnider says:

      I think Jim has this a bit to simple.

      I was thinking about the risk of doing nothing due to inflation.

      If it averaghed 3% per year, you would be down 24% to $2,379. Ditto for CD’s, bonds and treasuries based on Jim’s assumed rates.

      Bill Snider

  5. zapeta says:

    Ideally you would just adjust your withholding and not receive a tax refund and invest the money throughout the year instead. However, this gives a good look at the true cost of spending your refund on stupid stuff.

  6. Anon says:

    You forgot to factor in capital gains tax, inflation and trading cost. Try again.

    • Jim says:

      Well, inflation will affect all “investments” equally so ignoring it won’t be a big deal.

      If you hold the investment and only sell once, the trading cost is minimal relative to the rest.

      Finally, capital gains and income tax only exaggerate the results. Your income tax will reduce your gains from savings and CDs each year, whereas you don’t pay capital gains until you sell many years in the future.

      It’s an imperfect comparison but I believe it’s close enough.

      • billsnider says:

        What makes it more inperfect is congress changing the capital gains tax rate. That is a BIG unknown.

        Bill Snider

      • Anon says:

        I think if you factor in those 3 things you’ll find that your numbers are way of base. By keeping your assets in cash they’re slowly being eaten away by inflation. If you decide to buy and hold for any number of years you’ll most likely go with an ETF which will have a 0.2% – 0.5% annual fee. You and your readers may be surprised at the difference in results especially over the 30 year period.

  7. otipoby says:

    It has been a couple years since my MBA, but I remember the Capital Asset Pricing Model uses the market rate for the portfolio with maximum diversification. We always used either 5% or 5.5% in our homework. This was the geometric returns of the S&P 500 using the entire history. I seem to remember that their is a significant difference in your answer depending on your starting point.

  8. DIY Investor says:

    For what it’s worth: One time I calculated that the average family could save around $3,000/year by ordering water when eating out instead of soft drinks etc. This even after paying the kids $1 to order water. Actually give the kids a choice – they can order a soft drink etc. or receive a dollar to spend anyway they want. Kids tend to take the dollar and save it to buy what they want. A win-win for everyone except the dentist.
    Anyways Jim’s post is useful beyond the tax refund being invested. The $7,000, after 10 years, will go a long way at the local community college, even after inflation.

    • Fred says:

      I love this idea (about offering the kids $1 for getting water). I’ll bet there’s a whole post that could be made from an idea like this…

      For me, spending $2 on a soda while eating out is worthwhile. I like soda a lot; I enjoy free refills; and–quite honestly–$2 every now and then is small enough that it falls off the radar.

      But for my kids, $1 is big stuff (they’re 5 years old) – I’ll bet they’d take the dollar every time. There’s a dollar store near us that sells bow and arrow kits for $1. They last about 3 days before the boys break them, but for a buck they are well worth the investment – especially when you compare it to soda.

    • reducereuserecycle says:

      How many hundreds of times do you eat out a year and how many dozens of kids do you have?

      • DIY Investor says:

        Hey reducereusercycle-

        Thanks for calling me on my number.
        It was a while ago and I was sloppy. Let me see if I’ve got it right now.
        According to the National Restaurant Assoc. (2000 survey) the average family eats out 4 times/week or 208 times/year. My article had looked at putting aside $1 for a child each time the family eats out between the ages of 8 and 20, using the method described in the other post. Then on the child’s 20th birthday the family would have approximately $2500 (208 * 12) even if no investment return had been made. With an investment return it would be approximately $3400.
        I had written an article to show that it would be fairly painless to start an IRA for a child on his/her 20th birthday with a decent sum.
        Anyways I hope the arithmetic is fairly close now and again thanks for questioning my number – I don’t want people thinking I’ve got 50 kids!

        • Jim says:

          DIY, I think the skepticism was because you made it sound like people could save $3000 a year, not $3000 over 20 years.

        • reducereuserecycle says:

          You’re welcome. I’m kind of suspicious of that stat from the Nation Restaurant Association. I doubt that people eat out 4 times a week in the year 2000 or any other year.

          If they are counting drive thru than I think most people wouldn’t order drinks. But even counting drive thru 4 times seems really excessive.

          I think they might be playing with the numbers. Counting one of the family eating out for lunch during work as if all did. In other words members of that family unit may eat out 4 times a week but the whole family doesn’t.

          • Jim says:

            I’d be curious to know the standard deviation on that statistic because I bet you have a cluster at “eat out all the time” and “never eat out.” There are 21 opportunities to eat at a restaurant, so 4 probably isn’t that crazy of an “average.”

            Then again, 9 out of 10 statistics are made up on the spot.

      • echidnina says:

        Seriously! That’s some new math there… If it were a family of 5 people, and everyone ordered soda, and each soda cost $3 (and I think those are quite generous estimates), you’d have to eat out 200 times a year to save $3,000.

  9. eric says:

    Yup, I don’t aim to get large refunds but if I do, it’s an extra incentive to save it.


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