Tuesday, October 07, 2008

Kent's 401k Rant! (no really, read it, it's entertaining.)

The gracious folks at Sierra Wireless (makers of excellent broadband internet modems - check one out at your local Sprint, Verizon, or AT&T store today!) upgraded my laptop to a rugged new Panasonic Toughbook 52 (magnesium housing, built-in handle). Now if only our stock were worth something!

How about that financial melt-down? First the internet bubble burst, then the housing market, now the stock market in general. Commodities are next, I'm going on the record right now. (Then after commodities, "Green Company" stocks. You'll see.) It's all a house of cards as far as I'm concerned. Ever notice how the only people telling you what a great idea it is to put money in your 401k, are the people who run the 401k's? Explain to me again how I give up a hefty percentage of my income to a bunch of semi-literate stock brokers, and promise not to ask for that money back until I'm a few years from the grave? And when I do ask for it back, I get to pay taxes on it? And oh, by the way, if I would like to access any of my money before I turn 65 or whatever, I can not only pay taxes on it but a hefty early-withdrawal penalty as well? But cut the 401k managers some slack, they will let me borrow my own money back from them, at a substantial rate of interest. Huh? I can borrow money from myself, and pay someone else interest for it?

The year-to-date performance of my corporate 401k, held with Principal Financial Group: -15.52%. Way to go, Principal Financial! And I don't want to hear lame arguments about "long-term investing".

The Pension Protection Act of 2006 offers a little-known bylaw allowing activated Army Reservists such as I to make penalty-free withdrawals from their 401K plans. I liquidated mine exactly three days before the financial meltdown on Wall Street. Yes, you could say I am partially responsible for the crisis over at Dow Jones - people saw what I did and knew the gig was up. "Kent did what?!? He cashed in his 401k? He must know something! Sell! Sell!! SELL!!!"

The hard truth: Since 2001, Joe Average Investor would have been better off putting his post-tax savings underneath his mattress (or perhaps in gold) than investing in Wall Street, 401K or otherwise. Am I the only one who has noticed this? Or is the PR juggernaut behind the 401k companies too persuasive to allow people to think otherwise? I contribute the minimum amount to my company's 401k plan in order to get their matching funds, then that's it. I take every opportunity I can to pull my money out of the 401k plan, and use it to pay down my mortgage. "Whoa, whoa, whoa! Pay down your what?" (I can hear people thinking that, I really can.)

Oh yeah! Pay down the mortgage! Is there any better use for your money? I'll explain why in a minute. But first I'll dispel another piece of conventional wisdom. An ARM mortgage is not just a good thing, it's a great thing! A beautiful thing.

But first, the mortgage logic. If you are paying a mortgage, then every cent you spend is a mortgaged cent. Every dollar you spend is a borrowed dollar. Even if you are just paying the bills, buying Chinese take-out, or putting gas in your car - it's the same as if you are putting each one of those items on a Visa, with an interest rate equal to that of your mortgage. As long as your are paying interest on your mortgage, (say, 6% for the purpose of this illustration), then every dollar that you don't use to pay down the mortgage, you are essentially paying 6% interest on.

This goes for all your spending money, including the money you choose to put into a brokerage account or 401k. You basically have to make 6% profit on any investments in order to justify not paying off your mortgage with that same money. Think about that. How many investments out there pay a guaranteed 6%? (One comes to mind, for those fortunate enough to have an ESPP at their company). Pretty much zero, otherwise. The stock market, historically, maybe, if you average it out over 20 years, will give you 10%. Wow. So, as long as you are carrying a mortgage, the best return you can hope for on your 401k investment is maybe 10% minus your mortgage rate. In our example, that would be 10% - 6% = 4% return on investment. Wow! That really sucks! All that time, you could have been paying off your mortgage sooner, releasing yourself from debt sooner, and reaping a huge dividend in cash flow once the mortgage was gone.

Now for ARM's...or Adjustable Rate Mortgages. ARM's have been much maligned as of late, not for what they are, but for how they were abused. Ignorant, greedy Americans used low-rate ARM's to buy McMansions that were bigger than they needed and more expensive than they could afford. When the rate adjusted upward, they realized they couldn't make the payments OR sell the house because the market had tanked. Blame the greedy homebuyer? Blame the greedy mortgage broker who talked them into it? Blame the greedy bank that approved the high-risk loan? No! Blame the monetary instrument! That way no one's feelings get hurt.

Here is why I love our ARM mortgage:

1) The interest rate is pretty low, all things considered - lower than a comparable 30-year fixed loan
2) The loan is INTEREST ONLY. I only pay off the interest every month. But...
3) I can pay down the capital anytime I want, as much or as little as I want. And...
4) When I pay down the capital, the total monthly mortgage payment goes down! What a great incentive to pay down the capital!

So I am free to take that cash that I would otherwise be using to pay the capital on the loan, and stick it in my employer's ESPP (guaranteed 15% return on investment!) and then pay down the mortgage in big chunks a few times a year. We've paid down the capital 20% in the last two years - not bad!

None of the above strategy would work, however, if we hadn't made some critical choices to begin with. Here is the long list of critical choices we made:

1) We bought a modest-sized house that we could actually afford, in a neighborhood that we could actually afford, in a city that we could actually afford.

Oooh. Ouch. Yeah. (gulp) That's a tough one for a lot of people to swallow. I can actually hear the gagging out there. It's almost...almost...un-American to live within one's means, isn't it? Yeah. It really is. Hmmm. Oh well! If that's the case, then I guess I am un-American.

1 comment:

Anonymous said...

OK, Kent, I enjoyed your rant. However, let's not forget the tax deduction for mortgage interest.

If you really want to piss off the man, put money in your Roth IRA - did you know that you can take out the capitol that you put in it with no penalty? It's just the interest you've earned that has penalties associated with early withdrawal. Oh, and drug addiction.

Yes, I read your blog every day...