How to...: Top Ways To Invest Your Tax Refund

Instead of blowing your tax refund money on goodies or letting it languish in your checking account, put it to work for you. No matter how small your refund is, this article will tell you where you can invest it. 

Ally Bank CDs

If you're looking for a safe way to invest your money, a certificate of deposit (CD) from Ally Bank might suit you. This online bank offers three types of CDs: 

• The high-yield CD has terms ranging from three months to five years. Its rates vary from 0.84-2.99% (significantly higher than the rates of many of its competitors) depending on the term you select.
• The annual percentage yield (APY) on a five-year deposit, for example, is 2.99%, resulting in earnings of $794.53. Although this does not seem like a hefty return, CDs are safe investments and a better allocation of funds than wasting your return on unnecessary products.
• The penalty-free CD has an 11-month term and 1.35% APY. The rates offered by Ally are greater than those of competitive businesses.
   

All offers are FDIC insured, compound interest daily, have minimal or no fees and can actually be opened with $0.

High-interest online checking and savings accounts

These accounts offer considerably higher interest rates and lower fees than traditional banks. Ally Bank, ING, FNBO Direct and Everbank are all good places to start your research.

• Ally Bank lets you open an online savings account with $0 initial deposit and is paying 1.29% interest as of April 6, 2010. There is no monthly fee and no minimum balance.
• ING Direct's electric orange checking has no overdraft charges, no ATM surcharges and no monthly fee. You'll earn 0.26% APY on balances of $10,000, and all deposits are insured by the FDIC up to the regulated limit of $250,000. Minimal funds are required to open an Orange ING Savings Account.
• The FNBO Direct Online Savings Account is currently paying 1.25% APY and is not subject to monthly fees or a minimum balance. The savings account is easy to open, and offers individuals various resources to target their investment goals.
• If you have a larger refund to invest, Everbank also has a high-interest checking account with no monthly fee, but you'll need $1,500 to open an account. As of April 2, your deposits will earn 2.25% for the first 90 days, and 0.95% thereafter for balances of $9,999 and below.

Low initial investment IRAs

It is possible to open an IRA with Vanguard with a $1,000 initial deposit (much lower than what many financial institutions require) if you invest it in Vanguard's STAR fund (VGSTX). The STAR fund is made up of 11 actively-managed Vanguard funds. It has a low expense ratio (0.37%), no redemption or 12b-1 fees. It is a moderate allocation fund (meaning that it couples moderate risk with moderate reward) with a 10-year return of 5.10% and a lifetime return of 9.75% (returns, of course, are not guaranteed). Vanguard charges no annual fee if you meet certain criteria; otherwise the fee is $20 per fund.

While it is generally agreed in the finance world that passively managed funds tend to perform better over the long run, and while the risk profile of this fund is not ideal for long-term investors, who can try to maximize their returns by investing in higher-risk funds, this is still a reasonable option for opening an IRA if you don't have a lot of cash. When you have more to invest, you can always switch your investment to another fund.

If you don't have $1,000 to invest, look at opening an IRA with Zecco. Zecco charges a $30 annual fee for IRAs but it has no minimum contribution.

No transaction fee ETFs

Charles Schwab and Fidelity both allow you to trade shares of exchange-traded funds for free, with a few restrictions.

Fidelity has an arrangement with iShares, the world's largest family of exchange-traded funds. This arrangement lets you trade shares of 25 popular iShares ETFs for free (meaning that you won't pay any commission fees) through a Fidelity account. These ETFs also have very low expense ratios.

The ETFs you can trade through this program include S&P 500 (IVV), Russell 2000 (IWM), MSCI Emerging Markets (EEM), and many others that compose various investment style strategies. The ETFs available represent a wide array of investment options, from large-cap value to fixed income, so you can take on the level of risk that's right for you and diversify your investments. The cost to invest depends on the price of a single share of the ETF you want to purchase.

Similarly, Charles Schwab lets you trade ETFs in its own family for free, if you do it online through a Schwab account. There are only a limited number of such options, but don't let the lack of choices deter you. These ETFs also have very low, competitive expense ratios and come in a well-diversified array of investment options. For example, the Schwab U.S. Broad Market ETF carries an expense ratio of 0.08%, significantly less than iShares, SPDRs and even less than the comparable Vanguard exchange traded fund.

Before You Invest

With these options, even the smallest of tax refunds can be put to good use. But if you have any high-interest debt, you'll get the best return on your investment from paying that off first. It's also a good idea to make sure your emergency fund has several months' worth of expenses in it before you start investing.