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What’s the Best Way to Spend Our Tax Rebate?

She Says, ‘Pay Down Debt!’ He Says, ‘Take a Vacation.’

Q: I’m expecting a $600 tax rebate to hit my mailbox soon. My husband is tempted to splurge on a get-away-from-the-kids weekend with me. But I think we should pay down some of our credit-card debt. What’s the smartest thing we can do?

A: What’s the best thing to do with that extra dough we sometimes get after we file our taxes? Obviously, there’s no one right answer that works for everyone. 

If you’re making progress on paying down your debt and you and your husband really need that vacation, go for it! But don’t underestimate the peace of mind getting closer to your goal of being debt-free will bring you. At 19% interest compounded daily, the amount of money in interest payments you’d be saving by reducing your debt by $600 isn’t chump change.

            Some other options to consider: You could invest the money in the stock market, or stash it away in a savings account. MAKING BREAD asked ING DIRECT Chairman, President and CEO Arkadi Kuhlmann what advice he’d give to anyone tossing a coin to decide between those two choices.

"There's an old adage that says, 'If you can't afford to lose it, don't risk it.’ The stock market's not FDIC-insured, like a bank," Kuhlmann answers in characteristically direct fashion. “At a 7 percent annual return in the market, $600 would yield about $4,300 after five years, if you invest that amount each year,” he notes.  “But if the market drops dramatically, as we've seen with the recent volatility, it could yield zero in a day. So in my opinion, it would be a mistake to take that money and immediately invest it in the stock market, as many brokers will undoubtedly encourage people to do. A high-interest savings account is less risky and lets compounding interest do the work.”

 Always looking for good deals, MAKING BREAD logged onto www.ingdirect.com  and found another plus, besides the high [4.15 percent in May 2006] interest on its savings accounts that this Wilmington, Delaware-based direct savings bank offers. In an e-version of an iconic cultural ritual—Disney’s Uncle Scrooge counting his pennies in his money bin—consumers can go on line log into their account and literally gloat while they watch the amount in their savings account grow. “With our savings account, compound interest is accrued daily and credited monthly on both the principal and previous interest credited. And the money is safe, secure and readily available,” Kuhlmann explains.

A game? Maybe, but for reluctant savers, watching money grow can provide the incentive to save more. Added value: This electronic savings bank doesn’t deduct transaction fees. Nor do they have minimums or service charges. Because they don’t have the cost of maintaining traditional branch offices, they can afford to pass the savings on to their customers in the form of better rates than most competitors offer.

The bottom line: "If there are bills to pay, such as high-interest credit card bills, then by all means, consumers should pay down their debt first. If there's any amount left over after that, invest it in savings and watch the amount grow for a while. Once there's a nice little nest egg, then you can put some in the market if you want,” recommends Kuhlmann, adding that  "Americans have a very poor consumer savings rate compared with many other countries. “It's time to change that."

MAKING BREAD heartily concurs. Putting your $600 in an IRA is another savings option, but one with less flexibility, since you lose liquidity, or the ability to access it in an emergency. Of course, if you can afford to, you can always “pay it forward” by giving your windfall from Uncle Sam to your favorite charity. And you’ll probably feel almost as good as if you’d gone on vacation.

One final recommendation: If you continually find yourself getting large refunds, adjust your withholding amount so that you aren’t giving Uncle Sam an interest-free loan. It makes far more sense to have that money earning interest for you throughout the year!

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This answer was prepared by the staff of MAKING BREAD. As added benefits, subscribers to the magazine get unlimited, free responses to their “Ask the Expert” questions, plus a 20% discount on “Making Bread: The Ultimate Financial Guide for Women Who Need Dough.”

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