Don't Borrow Money From Your Retirement Plan
There are many sins when it comes to investing for retirement. Not putting the maximum amount you can put away in your 401(k) plan, or putting a lot of money in low-yielding investments, like Guaranteed Investment Contracts, are but two examples.
But the biggest sin of all when it comes to investing for retirement is borrowing from your nest egg. Believe it or not, people borrow from their 401(k) plans to finance cars, boats, homes and other items. There's no other word for this behavior than insane. The whole point of separating your money into different pools-one for current expenses, one for Junior's college education, one for retirement to name just a few-is to give yourself the discipline to stick with a plan for the long haul.
When you borrow from your 401(k) plan, you are literally mortgaging your future. You are saying to yourself "I'd rather enjoy myself now and damn the consequences when I'm 80." Even in the best of times, that would be foolhardy but given that part of Medicare, the government's health insurance plan for the elderly, is likely to run out of money in five years or so and Social Security is likely to be in the red by around 2020, borrowing from your retirement account is incredibly risky. Yet about 20 percent of people enrolled in 401(k) plans do borrow and face an enormous downside-not being able to repay the money and having zilch in the pot at age 65.
Banks are making it even easier to borrow 401(k) money with a new kind of credit card. Employees enrolled in a 401(k) plan could charge on a MasterCard or Visa up to 40 percent of the amount of money in their plans to a maximum of $10,000. Borrowers would repay the loan at the prime rate and the cash would go back into their retirement accounts. Of course, the banks would get a monthly fee of 3 percent to 4 percent of the outstanding loan balance.
Even if people borrowed and repaid all the money back in the same month with no deductions for interest, they would be foolish. Why? Because, their money isn't invested in stocks, bonds or mutual funds, which is critical to long-term performance. Most gains in the stock market occur in short periods of time although no one ever knows when they will occur. What if the market goes up 10 percent during that month. Compounded over time, the money in the account will be worth a lot less if it wasn't in the stock market.
Bottom line: don't violate the Cardinal rule of retirement investing: Never borrow against your 401(k) plan!
Go to $Idea Central for more investment ideas!