Turning your tax return into financial independence
Wondering how you can make the most out of your 2022-2023 tax refund? We sit down with an investment specialist to discuss the options.
Mentioned: Kogan.com Ltd (KGN)
With the end of the financial year upon us, millions of Australians are preparing to lodge their tax returns, and for many, that involves a sizable tax refund landing in their bank account in the coming months.
Last year, the federal government refunded more than $30 billion in taxes back to Australians, with the average lump sum hovering around $2,800 per person.
But with debt repayments, student loans, superannuation, and other investments all vying for financial attention, tax back recipients can often be unsure where best to place the new funds.
With that in mind, we sat down with Morningstar investment specialist Shani Jayamanne to discuss how best to put your refund to use.
Service your debt
Q: Should I use my tax refund to pay off debt?
Jayamanne: Rising interest rates have meant that the price of debt has risen. There are different classifications for debt, but if you are in a position where you have taken out a personal loan or credit card debt to deal with rising cost of living pressures, these debts in general, should be paid first.
There’s always a question of whether you should put any extra cash against your mortgage or invest. We explored this concept in detail a recent Investing Compass podcast episode.
A few considerations are:
- How close you are to retirement or paying off your mortgage
- The return expectations for asset classes and the interest rate
- How long you hope to hold your property
Education debt has been on a lot of graduates’ minds. More than 3 million Australians had their HECS/HELP debts indexed at 7.1% in the 2023 financial year, adding an average $1,700 to their debt.
Paying off your education debt depends on where you are and what your financial goals are.
Indexation is not an interest rate – it is increasing by the CPI rate. This makes it one of the cheapest debts that you could take on.
It does however, impact borrowing power especially if you are taking on a mortgage. It also reduces your take home pay – anywhere between 1% and 10%.
A payment to your HECS/HELP may increase your borrowing power or your take home pay if you are towards the end of your loan repayments. In most instances, it is worth putting your money to work somewhere else.
Replenish your savings
Q: Should I leave my refund in my savings account?
Jayamanne: In the environment that we are currently in, many Australians are struggling with an increased cost of living, with many pulling back or drawing down on their savings. The ABS has shown that the household savings rate has dropped consistently since July 2021, from 19.3% to 3.7%. This dramatic drop has shown that the majority of Australians are struggling with saving.
Cash is not just an asset class, it’s a safety net.
If you’ve found yourself dipping into your savings, replenishing your cash savings might be the best place to put any surplus cash from your tax return. This is also particularly important if you have dipped into your emergency fund – a cash buffer that will prevent you from selling down investments in the case of an emergency.
And it is important to note about an emergency fund is that it doesn’t matter how low the interest rate is, you still need to have one. If you don’t you could be forced to sell off shares during an event like the GFC – and you definitely don’t want to do that.
It is worth acknowledging that over the long-term cash isn’t going to do much for you. For instance according to Deutsche Bank, cash has had a negative .67% annual real return over the past 15 years. That means that just holding cash will result in less purchasing power.
If we go back 200 years the real return on cash is just 1.73% per year. Banks are offering interest rates that aren’t keeping up with the inflation rate. Although your real return isn’t going to be impressive, cash offers peace of mind.
Outside of your emergency fund, any extra cash received can reduce the pressure for retirees to sell investments to fund withdrawals, and it can be a good reserve to have to pounce on opportunities if valuations on quality investments drop.
Invest in the future
Q: Should I consider investing my rebate?
Jayamanne: If you’ve got no debt and have a comfortable reserve of cash for your emergency fund, and for your investment portfolio – you may look at investing your surplus cash.
There are tax advantages to putting that surplus cash towards your superannuation.
Just remember, submit a Notice of Intent to Claim or Vary a Tax Deduction (S290) form as any after tax payment made can be varied to a concessional contribution to get the maximum tax benefit (this is of course if you have not met your concessional contribution cap).
If you are younger, small amounts can make a large difference to your retirement income.
Take an example – you’re a 35 year old with $100,000 in your super, earning $100,000, with a rate of return of 5% p.a. over 30 years (and an average inflation rate of 3%).
If you had 11% compulsory super contributions, you would have $1.05 million (after the 15% tax contribution tax). If you contributed an extra $1,000 each year, you would invest a net of $850 a year.
This would increase your portfolio value by $59,000 by the time you retire. That’s a couple of good holidays.
Outside of retirement goals, adding surplus cash to your investments may be the right path for you.
When investors receive extra cash, they may decide to take a punt on a risky stock – or an up-and-coming investment.
The ASX Investor Study 2023 has just been released – it shows that the most common place where investors are getting investment ideas is from family and friends.
This is worrying – it means that investors are making investments in securities that they have not, in most instances, researched themselves, have no enduring confidence in and most likely do not align with their financial goals.
Taking this approach means that there is a much higher likelihood that they will sell out of the investment if there is any volatility with the stock price.
Investors should consider their investment strategy, the existing regular contributions that they are making and where they are making them.
The best path may be to just increase the contributions to those investments. This will limit poor behaviour when investing and will ensure that you are investing for the long-term instead of betting on a hot stock.
Where we see undervalued, quality opportunities
Jayamanne: Successful investing revolves around holding quality investments acquired at an attractive price. Underpinning this is ensuring that the investments align with the goals of your portfolio – this could be income, capital growth, low volatility, etc.
For the former, Morningstar’s fair value estimate tells investors the intrinsic value of the market, helping you to see beyond the present market price. We achieve this by rolling up our analyst coverage in each market to an aggregate.
This allows investors to see how cheap or expensive a particular market is.
Currently, we see Australia and the US as fairly valued, with more opportunities in markets such as the UK and China.
This, however, does not mean there aren’t pockets of opportunity closer to home.
Morningstar’s Equity Best Ideas list is released monthly and contains a curated list of stock ideas from our analysts.
Current opportunities include funeral provider Invocare (IVZ) and online retailer Kogan (KGN).