Beating Broke

Personal Finance from the Broke Perspective

Sometimes Saving is Wrong

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Invariably, every few months, we get a wave of posts talking about “what would you do if you won $x,xxx,xxx?”  Or, what you would do with a smaller windfall.  And invariably, a majority of the people talk about how they would save the money.  And in some cases they are right.  But, most of the time, they are wrong.

Why are they wrong?  Because they’re looking at saving from the wrong direction.  I wouldn’t save a dime of it.  I would use every last cent of it to pay off debt.  And until I have no more debt, that’s what I would do every time.  Sure, maybe I’d by a few things that I needed, but the rest goes to debt.  Saving in a savings account doesn’t do you damn bit of good if you have debt.

If you have any debt at all, you really should think twice about having any savings at all except for an emergency fund.  Why?  Because, there is no savings account in the world that will guarantee you more interest than what you are paying on your debt.   If you pay off $100 of your credit card debt, you’ve just earned the 19% interest that you would have paid.  You “saved” more with that $100 than you would have in years if you had put it into a savings account.

Don’t fool yourself into thinking you need to have anything more than an emergency fund in the bank.  All the rest is just money that could be making you 19% interest instead of the paltry 1.30% that you’ll get at that high-yield online savings.  When you get rid of your debt, then is the time to start building your savings!

Some of you will likely ask “what about retirement savings?”  That’s a gray area.  There are some that would argue that if you don’t get that debt paid off, you’ll end up taking that money out early anyways.  Others would argue that due to the tax benefits of retirements accounts, and the magic of compound interest, you really should be putting money into your retirement too.  My current opinion is stuck somewhere in between.  I think that you should be putting a little into retirement, just so you have something going.  But, I also think that you should keep in minimal until your debt is gone and then ramp it up like gangbusters.

So, what would you do if you won $x,xxx?

401(k) Loans as Recession Insurance?

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With a recession (depending on whom you ask) upon us, would it have been wise for us to have taken a loan from our 401(k)s before it started?  Bear with me here for a second.  A loan from your 401(k) is pretty simple.  You borrow the money from yourself and then repay it to the 401(k) with interest.  The interest is usually something low.  Normally, it’s a bad idea, as the market usually performs as well, if not better, than the interest on the loan.

But, if (and that’s a big if) you were able to time the market relatively well to know there was going to be a downturn, you could loan the money to yourself.  Because the money would not be in the account, it wouldn’t suffer from the loss of value in your investments.  And instead, you’d gain whatever the interest rate was that you loaned the money for.  Instead of a double digit loss, you could have a relatively decent gain.  In theory it could work.

In theory.  The catch here is that you would have to time the market correctly.  If you missed it by a day, you could cost yourself some money.  If you were totally wrong and the market rallied, you’d end up missing out on possible gains.  But, if it worked, it could work out pretty well.  In the end, the more I look at it, it’s really a form of gambling.  You’re gambling that you can time the market and save your money.

Gambling is never a safe bet when it comes to your retirement.  It’s always tempting though.  It’s important to remember that a fall like we had over the last few years almost always comes back up.  You haven’t really lost money so much as lost value.  There’s a big difference there.  And if you keep contributing, which you should, you’re buying the very same investments at a bargain price.  So, instead of trying to minimize your losses by pulling your money out, you should be increasing your investment to maximize your return when the account finally bounces back up.

You Are Not Losing Money In Your 401(k)!

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I was watching my local news when they did a spot on people who were vacationing a little closer to home this holiday season because of the economy or other reasons when one of the people who they interviewed blamed their need for staying closer to having lost money in her 401(k).  Besides the fact that that money is, for all intents and purposes, off limits until you retire, and really has no effect on your current financial standing, how do you lose money in your 401(k)?

Did it get misplaced?

I’m being a bit facetious here to prove a point.  To lose money implies that the money is no longer yours.  Except that the majority of your “money” in a 401(k) isn’t actually money.  It’s shares of companies or mutual funds or index funds or ETFs.  You aren’t losing money.  You’re losing value.  The securities that you purchased with your money are not as valuable as they were when you bought them.  You still own the same amount of securities, which you converted your money to, so you still have all of your money.  It’s the value that you’ve lost.

Better example.  You buy a car for $10,000.  After driving the car for 5 years, you sell it for $5000.  Did you lose $5000 on the car?  Not really.  Very few people will think of it that way.  Because most people do not assume that they will gain value in a car, so they accept that they will not be able to sell the car for the same amount they bought it for.  And it is almost guaranteed that it won’t gain any value.  Again, though, you lost value, not money.

Losing value isn’t as bad as losing money. Why? Because, unless you need to realize that value immediately, you have time to wait and see if the value does go up.  And with securities, chances are that they will.  And in a locked up instrument like a 401(k) with all it’s penalties to discourage realizing that value until retirement, many of us have decades to wait and see how things turn out.  And, if I were a betting man (which I am sometimes), I would put pretty good odds on my 401(K) gaining value between now and when I need to withdraw any of it.

Note: I don’t encourage waiting to see if the value of your car will go up.  Unless you plan on waiting decades for that also in hopes that it will become a classic collectable.