Small Fish, Big Pond

Inspired by posts from “Get Rich Slowly“.

“The charge is bank robbery. Now, my caddie’s chauffeur informs me that a bank is a place where people put money that isn’t properly invested. Therefore, robbing a bank is tantamount to that most heinous of crimes, theft of money.” – Judge Whitey (Futurama)

Maybe that quote is a bit extreme. It is after all a joke made by a fictitious pompous rich WASP judge from the future; but it sticks in the back of my head when people tell me they plan for their future by stashing money under their mattress or buying gold coins.

I’m not a fool when it comes to money. My parents had a lot of financial issues while I was growing up and through their mistakes I was able to learn how to be responsible with my money even before I had enough money to worry about.

But one thing I always dragged my feet on was planning for retirement. What kid in their 20’s plans for what they’ll be doing half a decade in the future? We’re worried about getting a cool car, socializing with beautiful women, and finding out where the party is at Friday night (new lesson learned, the appeal of a cool car wears off early but the need having reasonable transportation will stay).

There is a lot of good financial advice out there but let’s face it, your attitude to financial planning at “25 and single” is a worlds different from your financial planning at “45 and married with kids”. I even try more than my peers to listen to all the advice given but retirement seems like such a small problem when I’m busy trying to figure how to get the bank to give me a loan so I can purchase some transportation to work. I’m not worried about retirement if I can’t even maintain my job to begin with.

A few years ago when my father was trying to organize his financial mess I learned a key item about retirement accounts I never knew. My parents had been slowly digging themselves out of decades of debt and the future looked bright but some emergency issues had cropped up and the only way to cover them had been to pay by credit card (new lesson learned, keep a healthy emergency fund for emergencies over $1000). It would take over a year to make up the credit debt and the 25% interest rates in that time would be murder to the newly balanced budget. My dad told me he was going to take money out of his 401k.

I didn’t know much about retirement accounts but I did know that pulling money out early leads to massive fees. I told him that losing money in early retirement fees wasn’t any better than losing money in credit interest, plus with retirement only a few years away it was damaging for his already small retirement (he had started saving late, another lesson learned), and that if he could just hold out a few years he’d have more help.

Then he told me he wasn’t withdrawing his 401k, he was pulling out a loan against the 401k.

It’s a key difference. In one case you completely remove the money, it’s taxed; and if it’s early additional fees are tacked on. The loan is not taxed, and there are no fees; the key point being that you will pay it back into the 401k like any other loan.

This allowed me to see retirement accounts in a different light. I’d always thought of them as basically like a big savings account that you can put money into but you can’t touch until you’re 65. And while treating it like this is ideal for retirement, when you’re 25 taking $60 out of your paycheck and not seeing it for another 40 years is a big deal. I could seriously use that money now.

So dad got the loan, there is no approval process and no loan officer to beg for money. If you want it it’s yours so long as you pay it back before retirement. Having learned this I finally took the plunge and started my retirement account while in my 20s. Of course now that I’m in I don’t know why I didn’t start earlier, I barely miss the $60 a paycheck and employer matching has caused the 401k to balloon faster than I ever imagined. And the fact that I now have a pool of money I can responsibly loan to myself makes it mind boggling that people still don’t immediately start building their own retirement accounts.

The loan is really like any other (I have Fidelity but most companies are similar):
-You arrange a payment plan of X dollars a month over Y years and the money is automatically deducted from your paycheck before you touch it, removing the temptation to spend it and the problem of not paying on time.
-You still pay interest but you get a decent rate, usually better than any bank will give you.
-The interest you pay goes back into your own retirement account.
That’s worth saying again.
-The interest you pay goes back into your own account, not the bank and not the company holding your 401k. It goes back into your own pocket, even if you don’t really get to pull it out of that pocket it until retirement.
-Than means that the only money unrecovered is the ~$30 processing fee to make the loan.
-And depending on who your 401k is through all this can be done online.

Now obviously this isn’t something you want to make a habit of using but it’s an excellent tool to have at your disposal when compared to paying 25%+ interest to a credit card or paying hundreds of dollars in interest to a bank loaning you money.

There are caveats of course:
-You can only have two loans at a time.
-You can’t take out more than 50% of your 401k in loans.
-If you lose your employment with an outstanding loan the company holding the account has the right to demand immediate payment (but will usually work out a payment plan with you).
-You can’t make extra incremental payments, but you can pay the entire remaining balance early.
-Unless you stop it, you will still be withdrawing X percentage to you retirement as usual, in addition to the loan payment.
-While your loan is out that money is not invested, same as if it was withdrawn from your 401k completely.

A lot of people say that that last caveat is the reason you should avoid 401k loans, as the money that is loaned out it is not invested, thus hurting your future retirement.

However the door swings both ways in this case. In the summer of 2008 I had my own emergency; a few weeks before a 3 week vacation to Japan a relatively trivial medical emergency cleaned out my vacation fund. Rather than let a poor healthcare plan stop me I pushed onward and went on my trip…
Paid mostly on credit.

I got home and had my chance to put the 401k to the test. In less than a week had tapped my now $8,000 401k for a $4000 loan avoiding the interest fees from the credit card. Before you freakout I knew I had about $1500 in reimbursed school funds coming soon, and calculated the other $2500 could be paid in about 8-6 months if I buckled down. I had set my repayment options to the bare minimum stretching out the loan to a few years but with small withdrawals per paycheck but planning on paying it off early. Various things cropped up and I still had a lot of that money out on loan in September 2008 when the market nose-dived.

I decided to follow the old adage of “Buy Low” and waited till the market plunge leveled out in April before paying off the loan with money I had been saving in the intervening months. As the market bounced back that $2500 loan pay off multiplied along with it.

So yes money on loan isn’t invested but in some cases that’s not a bad thing, especially if it’s being put to good use eliminating a more pressing financial emergency. Obviously I was lucky in my circumstance and nobody should try to game their retirement accounts playing with loans to get the same outcome. But it does prove that a negative can be turned into a positive with a little bit of planning.

The main thing I hope people take away from all this, especially those of us in the under 35 age group, is that not only is it good to plan for retirement now but that your retirement account can still be useful in the intervening 40 years. The quicker you start the bigger that cushion will be to help you out of a jam.

As long as you’re responsible and don’t abuse it you have a source you can loan to yourself, pocket your own interest during the payback, and have it all waiting for you as a retirement account when you reach 65.

The gains in the last week have been almost too rapid that I think we’ll still see days below 8500 in the future. But like I said this is far better than I think anybody could have hoped for at the beginning of this year. Unfortunately the real world we live in feels the fallout longer than the market so even if we jump to 10,000 by Christmas (could you imagine!!) then it will still take a year or so for the real world to stabilize under the highs of Wall Street.

It’s funny that I hear people now saying that with the market at 9000 already that it’s proof that the stimulus bills were unneeded. Um… I think the reason it’s this high already is BECAUSE OF the stimulus bills; this is exactly what they were supposed to do, they just did it better and faster than we thought they would.

That was me in July. Today the DOW broke 10,000 (hasn’t closed yet so I don’t know if it will last the day). All I can say is that from a financial perspective I’m loving it. In May I calculated that if the DOW had stopped at 8000 my 401k would have generally fully recovered in August of this year, every point beyond has just been multiplying my gains.

I never though we’d recover to 10k within the year, let alone by October. Now if we could just get businesses to calm down and start hiring again we’ll be good.

Technically the market hasn’t really done anything ground breaking today, 10000 is an arbitrary number, the real big events occurred in March and July, and today is no different than the last couple months of growth. The point is that it’s a generally steady rise upward to this point which is good.

On the otherhand if you’ve been planning on investing to take advantage of the low market the door is closing; it can’t go up forever and the real time to jump onboard was the first half of this year. Still it’s good to invest over long periods anyway; so there’s no reason to wait before re-investing in the market (my co-workers think this is crazy and that Obamma is going to destroy the market and the country in the next year or so, but I work in the reddest area of the reddest state). If you haven’t felt confident about the market in over a year now is the time to get your feet wet again.

This is all very reassuring news that the economy has more bright days ahead of it than dark.