How to Turn Your Tax Refund into a Million Dollars

Now that tax season is behind us many of us will be wondering what to do with our tax refunds. According to the IRS the average tax refund this year is running right around $3,000. The smart thing to do would be to turn that refund into more than a million dollars.

How? Through the power of peer to peer lending and compound interest. It was Einstein who said that compound interest is one of the most powerful forces in the universe and peer to peer lending allows average investors to unleash that power in a dramatic way. To understand this power take a look at this chart.

Initial investment$3,000$3,000
Annual additions$5,000$5,000
Years to grow4040
Interest Rate7%10%
Value in 40 years$1,148,986$2,818,093

Let me explain the logic here. You start your investment this year with a $3,000 tax refund. Then you invest your tax refund every year for the next forty years, which I am assuming to be an average of $5,000 (this is likely conservative as inflation kicks up the average refund). I show a conservative number where you receive an annual return on your investment of 7% and one where the return is 10% (this latter number is closer to the return numbers both Prosper and Lending Club promote).

I chose 40 years because it really shows the power of compound interest, and for anyone under the age of 35 it provides a realistic time horizon. I am also assuming that you reinvest all principal and interest payments back into your p2p lending account on a monthly basis.

Now, I hear people saying that $1 million dollars will not be worth nearly as much in 40 years time. That is correct. If we assume 3% inflation over the next 40 years then $1 million will be worth around $296,000. But it is a mythical round number that we still use to measure wealth and I am using this number here to make a point.

Of course, there is one glaring omission in my calculations. Taxes. Yes, they will dramatically reduce your returns. But this doesn’t have to be the case, which is why I have omitted the impact of taxes in this table. The smart investor will invest in an IRA thereby eliminating the negative impact of taxes. Anyone who earns an income can open a Lending Club IRA (but you need a minimum balance of $5,000 to avoid the $100 annual fee). At this time, Prosper does not offer an IRA option.

Here is my main point. Most Americans get a tax refund every year. Many people consider this “free” money, so why not do something positive with it. If you invest your tax refund every year for 40 years into a high interest paying investment like p2p lending you will be end up with a large sum of money in 40 years. This sum will most likely be well over a million dollars.

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Dan B
Dan B
Apr. 22, 2011 4:48 pm

I have no need whatsoever for $1.1 million when I’m 75. But I tell you what…………..I’ll put $3000 a year every year until I die into any investment you like starting right now……………& you cut me a check for $300k when I’m 55. That’s it, you can keep the rest. What do you say Peter?

Dan B
Dan B
Apr. 23, 2011 12:30 am

You don;t have to look at this as a wager. Just think of it as a reverse annuity with a twist. Besides, life is just a series of wagers anyway. I mean you have car insurance don’t you? You’re wagering you’re going to crash & the insurance company is wagering that you don’t. You win by crashing. Win too often & they won’t bet with you anymore. And of course you’ve already undertaken the largest wager of all………….marriage. So, what’s the big deal. All you need to know is that I’m between 25 & 50 yrs. old. 🙂

Aaron
Aaron
Apr. 24, 2011 10:23 pm

I only invest for the short term. I highly doubt that this fiat currency will be the medium of exchange when I enter my 60s (I am in my late twenties.) I invest 15% of my income to my 401k for retirement, but have little to no faith that I will ever be able to use it.

I am more in favor of investing in a way where I can retrieve my money when I need it rather than in an IRA. I am happy to pay the yearly taxes for the privilege.

Peter, yes taxes are a glaring omission, but you are still going to have to pay them on your IRA. Either on the front end or the back end depending on what IRA you choose. What do you think taxes will be like in 2050?

Dan B
Dan B
Apr. 25, 2011 12:47 pm

@Peter…………You see they have you brainwashed already. Why don’t you send me three quarters of your car insurance premium & I’ll cover any expenses involving any incident you might have with either of the 2 Aston Martin DB9s that live in Colorado. 1 of which rarely leave their garage. While you’re at it please send me your life insurance premium too & I’ll take care of that as well. I’m willing to take the chance that you’re not going to die anytime soon. If you have anything fun like earthquake insurance then I’d love to have that premium as well. And if you do nothing else please send me just half of all the money you’re planning on spending for extended warranties on anything. I’ll cover all those for you too.

Dan B
Dan B
Apr. 25, 2011 1:16 pm

And no I don’t have life insurance. The idea that someone benefits financially from my demise makes me a bit nervous. 🙂

Dan B
Dan B
Apr. 25, 2011 3:58 pm

@Peter……….I was just semi-kidding of course. Then again the best way to protect against that million dollar liability is to “appear” not to have any real money. Without breaking any law of course.

Wait, you only pay hundreds of dollars a year on car insurance for full coverage!

Aaron
Aaron
Apr. 26, 2011 6:25 am

I stand corrected on the Roth, but on a side note……Who gets $3,000 back from the government? I always have to pay money every April. I like it that way. Better to have your money in LC or P earning 5% than in the government’s coffers earning 0.00000000000000000000000000%

🙂