When tax season rolls around, it seems everyone — from car dealerships to airlines to realtors — is jockeying for a piece of your client’s refund before it reaches their wallet. As a financial advisor, it’s incumbent on you to emphasize that the best move might be to not spend that money at all — as tantalizing as a trip to the Bahamas may sound.
That’s because tax refunds can make an excellent addition to your clients’ long-term wealth management and retirement plans. But with fewer than one in 14 Americans planning to invest their tax returns this year, financial advisors need a game plan to get through to them.
To help them get the most out of their refunds, here are a few rules of thumb for advisors looking to jumpstart their clients’ wealth management and retirement plans around tax time.
With today’s markets liable to shift at any moment, it’s easy for clients to think that any investment is a losing investment. Counter that concern with the rule of 72, a simple way of explaining how long it will take an investment to double through compounding interest.
An easy way to illustrate this is by using the compound interest calculator on the SEC’s website. You can outline how far along your clients would be if they were to set aside a small amount of the refund they get back from the IRS every year.
Remember that there's no one-size-fits-all approach to investing. If your clients are among the millions of Americans who would struggle to cover a $1,000 emergency, they should consider using their refund to create an emergency fund first.
If they're farther along the road to retirement, remind them it’s beneficial to max out their employer 401(k) or 403(b) plans. And if they’ve already done that, suggest opening a Roth IRA. Since Roth IRA withdrawals are tax-free in retirement, they can blunt the impact that rising income tax rates may have on their nest eggs.
The race toward retirement isn’t a 500-meter sprint — it’s a marathon. Inexperienced investors can get swept up by headlines promising to make them overnight millionaires. Advise them not to fall for it.
When it comes to long-term investments, clients should be encouraged to stick with traditional asset classes like stocks, bonds and mutual funds. Markets that trade in cannabis stocks, cryptocurrency, international currencies and other specialized investments are subject to evolving regulations and could expose them to pump-and-dump schemes and complex tax situations.
No one can predict when the next recession will hit. But if your clients are concerned about investing in today’s turbulent market, they don’t need to put their money in all at once.
Instead, they can use dollar-cost averaging, a strategy to manage risk by investing at regular intervals. This can take the emotion out of investing for those keeping an anxious eye on their account balances. And while this strategy may not yield sky-high returns, it can also help minimize their losses.
While there are many ways for clients to make sound investment decisions with their tax refunds, it’s important to understand their entire financial picture before giving advice. Get a holistic perspective on where they’re at, and what they aim to achieve long term, and go from there.
Nasha Knowles, a certified financial planner with Equitable Advisors, is CEO and founder of Fortress Wealth Advisory.
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