I’m seriously considering a 401(k) loan.
For the past few years, I’ve been contributing to my retirement accounts, and this year, in 2018, I will max out my 401(k) at work for the first time.
Currently, I have just over $40,000 in this account, and recently, I’ve been having many thoughts on why I have this much money stored in such an illiquid asset.
In this post, I want to touch on a number of things regarding 401(k) loans, the current state of the economy and markets (in my eyes), and talk about why I’m considering a 401(k) loan.
Disclaimer: I’m not a financial adviser or financial professional. Please do you due diligence and research before buying or selling financial securities and assets.
How do 401(k) Loans Work?
First, let’s lay the ground work with some definitions and examples of what a 401(k) loan actually is.
While many financial advisers say “never touch your retirement accounts”, I think a 401(k) and Roth IRA could be great sources of cash (if tapped in a smart way).
One thing to point out here: a 401(k) loan and withdrawing from your 401(k) are two DIFFERENT actions. Withdrawing from your 401(k) potentially comes with fees, penalties, and taxes.
Taking a 401(k) loan is different.
With a 401(k) loan, you are taking a loan funded by your past contributions. You end up liquidating a piece of your account, and get it tax-free.
This piece of your account cannot be more than 50% of your account balance, and cannot exceed $50,000. For example, if I have an account totaling $30,000, then I cannot loan myself more than $15,000.
Most 401(k) loans have some sort of upfront fee, and then you pay the loan back for yourself at a certain interest rate (typically, Prime Rate+ 1%, or 6.25% as of today).
Paying back your loan happens over 12 to 60 months (depending on what you choose). The payments come out of your paycheck.
There is a risk here. If you don’t pay back your loan, it’s considered a withdrawal and you will possibly be hit with fees, penalties, and taxes.
Also, if you leave, or are fired from, your job, you’ll have to pay back your loan in full, or the remaining amount will be considered a withdrawal.
There are a number of benefits and negatives to taking a loan out of your 401(k), but it should not be a definite no when considering ways to access YOUR money.
Now that we have established what a 401(k) loan is, let’s get into the meat of the article.
Related… a challenge here… what’s the difference between taking a 401(k) loan and not contributing at all?
A Dangerous Misallocation of Capital to Non-Productive Industries
Over the last few months, I’ve been embracing a number of alternative thoughts and thinking critically about the world around us.
I want to talk about something not many people are discussing: in the 21st century, capital has been misallocated in a very dangerous way, and now, is having huge effects on society.
Social, political, and environmental problems at their core are a result of wonky monetary and fiscal policy and incentives gone wild.
Think critically for a second: historically, what drives productivity and wealth?
Companies and customers, working in a synergistic relationship, drive productivity and wealth. Markets, political systems, and the environment will govern what this looks like in reality, but at a high level, it is companies, employees, customers, and consumers who drive the economy.
Currently, this relationship is out of wack. It should not surprise you for me to state that fact. The distribution of wealth and income is at levels not seen for 50-75 years!
The last time these lines were close to each other was the 1930’s (when the Great Depression happened).
The 1920’s were a roaring time, but what is commonly left out of storytelling is how the financial markets was a huge, debt-driven bubble. This bubble ultimately burst and laid waste to companies, housing, families, and the government. Without extreme measures in 1933 (FDR’s Gold Confiscation), the economy would have collapsed completely.
Now, we are at a time where there is a similar wealth and income distribution between the rich and the non-rich.
Financialization and the Misallocation of Capital in the 20th and 21st Century
How have we came to this point?
Starting in the 1970’s, a number of things have happened which has lead to growing inequality and a misallocation of resources: unsound money, decreasing interest rates, globalization, and financialization.
During the 1980’s, there was some amazing innovation and opportunities in many areas of the economy. One of them, which I’ll highlight here, was the explosion of Wall Street. Why try to find the next big invention when you could just trade the companies’ shares? If we can finance the deal and get a handsome fee, why take any risk?
It started a cycle: more talent went to banking and finance because of the higher salaries, and as the salaries kept rising, more attention was placed there.
The Great Recession (2007-2009) was caused by the financial industry, and yet they came away unscathed.
Another development I want to highlight is globalization. Instead of investing in employees in the United States, profits were prioritized, and wages have stagnated, statistically, on a national scale.
Historically low interest rates, government subsided loan programs, and corruption I’ll also throw in here. These things have lead us to a massive bubble, instability in our social and political systems, and inequality of wealth today.
Now, you have companies Facebook and Apple who are “leading” the way with digital products. Does everyone need a $1,000 iPhone? How is this productive (in the grand scheme of things)? Why isn’t there more focus on sustainable energy, housing and health?
This is what I mean by MISALLOCATION of resources. 50%+ of the population is struggling in debt up to their eyeballs, and yet, because companies and investors can get “returns” from selling them a handheld piece of crap, it’s worth it to pour millions and billions of dollars to squeak out more money.
I’m being over the top here with the example of Apple, but I’m trying to drive home a point that we live in a crazy time. For some reason though, it feels normal because it’s been going on for so long.
Why I’m Considering a 401(k) Loan
Let’s get to the real purpose of this article. I have a number of investing and economics posts on this blog, but this article is about why I’m considering a 401(k) loan.
First, I’m struggling with my alternative thoughts on how markets revert to means over time. I don’t want to play into the misallocation of funds anymore.
I want to provide VALUE to the world. There are a few other reasons why a 401(k) might make sense here.
At a high level, these reasons are:
- If I want to become VERY wealthy in the near future, I need to take on a significant amount of RISK.
- Many backwards looking calculations show an average rate of return for stocks of 7% over time. I believe I can do better with my entrepreneurial efforts and investing.
- There are numerous stock market headwinds (valuations, increasing interest rates, massive debt, and an aging population) which are not favorable to for returns in the next few years.
Gotta Risk it for the Biscuit
If you’ve poked around on this blog before, I’ve tried to make it clear that I’m trying to build extreme wealth at a young age.
I have a goal to become a millionaire by the age of 30.
The equation to building wealth is simple. It is simply:
Future Wealth = Current Wealth * Return * Time + (Income – Expenses) * Return * Time
Take your current wealth and multiply by some return and time. Take your income, subtract out expenses, and multiply this difference by some return and time. Add these two numbers together and you’ll get a projection for your future wealth.
I’m ignoring a ton of variables here (YES, the return will be different depending on situation and asset class), but at a high level, this is the wealth equation.
Filling in the numbers here, I’m currently at just under $200,000 in net worth. My income minus expenses is about $50,000 a year.
By staying on track with my savings, I’ll be at a net worth of roughly $400,000 at the age of 30 (a great achievement, but well short of my goal).
The one variable I haven’t touched here is return. To seriously increase wealth, I need to take a lot of risk to increase my wealth through investment returns and/or increasing my income. There is no such thing as a free lunch.
Look, the stocks and bonds in my 401(k) are not going to get me to my goal. 7% (???) over the next 4 years on my investments is not going to move the needle. I need 50%, 100%, 200% gains on my money through my various entrepreneurial endeavors, asymmetric bets, and strategically allocating money to improve the value of my work and assets.
Strong Inner Belief
I can already hear the haters.
“You can’t time the market!”
“Don’t touch your 401(k) – you are losing out on compounding!”
“You are stealing from yourself!”
Throughout my life, I’ve spent various times with massive chips on my shoulder. Each time, I’ve pushed to become better and the outcomes have been great.
I’m the owner of my life, and I can do AMAZING THINGS.
I can do achieve anything I put my mind to.
I’m the owner of my actions and choices, and have an incredibly strong belief I can accomplish my goals.
This strong inner belief applies to my money and wealth building habits and strategies. I can and will be disciplined with my earnings, hustles and investments to build wealth over time.
I cannot let the “markets” do their dance and play me like a fiddle.
I’m in control here.
Headwinds to Traditional Investments
Besides all of the stupid motivational crap I just wrote in the last section, the outlook for future returns do not look great in the financial markets.
Short term bonds are yielding about 2.25%. Long term bonds are yielding about 3.25%. Stocks and companies have huge headwinds from debt and valuations being higher than they have ever been.
What could have been an incredibly bullish use of funds at the beginning of 2018 (tax cuts) turned into a dud. Corporate buybacks is the biggest waste of capital in the world today.
This alone makes me feel negatively towards stocks, among the countless other factors I’ve talked about here and on the blog before (government debt, student loans, corporate debt, high valuations, an aging population, a depreciating dollar, and instability socially and politically).
A quantitative blog I’ve really enjoyed reading lately is Fat Tailed and Happy, by a PhD Economist. I appreciate how he takes into consideration many assumptions and variables when doing an analysis (and doesn’t cherry pick or ignore key assumptions to make things look good).
One of his best posts looks at the yield curve and valuations of stocks. What the author argues and shows is the yield curve is an important predictor of equity performance in the intermediate term.
Based on the author’s analysis, the 5 year annualized returns based on where valuations are in 2018 are negative. Looking out 10 years, the 10 year annualized returns are near 0%.
At a 6.25% interest rate, the 401(k) loan statistically speaking seems to be a decent bet against bonds and equities.
Taking a 401(k) Loan Has Downsides as Well
As I mentioned above, there are a number of risks and downsides to taking a 401(k) loan. There are other financing options available to me, and I can always just hustle a little harder to save up money for a splash in another investment or opportunity.
I’m just nervous and weary of how I’ve over-allocated my personal portfolio for a time over 30 years from now (is there any guarantee I’ll even be able to access it then???).
I believe in myself and believe I can do amazing things.
Maybe I’ll be right and achieve my goals. Maybe I’ll be horribly wrong and end up broke.
At the end of the day though, I do NOT care if I’m right or wrong about what I’ve written above.
A quote that stuck with me from a book I read the other week:
To get a woman, you need to be willing to lose her.
While the book was about dating and relationships, this quote applies to this situation and goals.
If I want to become wealthy, I need to be willing to lose my wealth. No, that doesn’t mean I should be careless and stupid with my money.
No, it means I should take smart risks with my money and look to strategically grow it (but also not be afraid of this potential growth).
I could also become a millionaire at 30 through strategic action taking. Buy low and sell high, take continuous action and work towards becoming better every day – this is my plan.
At the same time, the financial markets might continue to go bananas. The government might be able to get out of their fiscal mess. The dollar might reign supreme forever. My businesses could fail. I could get sick. I could get laid off from work.
If I’m wrong, I’ll accept the consequences and life will go on. It will be a learning and growing experience.
If I’m right and take the actions necessary for success, I’ll be very wealthy at a young age. I will be an overnight success (4 years from now).
I’m not sure if I want to do the 401(k) loan yet, but my rationale for why has been documented. What would I do with the cash? Invest in myself. Invest in my businesses. Invest in undervalued assets. Now, I just need to figure out what’s best for me.
Thank you for reading,