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.
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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.
