An article by BudgetQueen
What is stopping you from investing in your 401K? Is it possible that you are contributing too much to your 401K? Is a 401K always the best investment for you? Well let’s sit down and talk…
A lot of people have fears about investing in today’s economy. Or perhaps you had a 401K once and you cashed it in, or lost a lot of money on it so you quit investing. Or if you have a 401K believe it or not, you may be even contributing too much to it!
Regardless, a 401K is an important investment and it is time to revisit your 401K and make any necessary adjustments.
A 401K is like a skyscraper in New York City
In New York City, they don’t have a lot of space for buildings – so they grow upwards. In just one skyscraper alone you could have hundreds of different businesses. All of them work together to make a successful entity.
That is what a good 401K is – something that houses a lot of investments. It is not just an investment in one company – it is an investment in different companies, different stocks, different types of investments and even investments in the stocks and investments of different countries. It changes over time as well as companies come and go. All of this is meant to keep it growing even when times get tough.
A 401K is also like a cherry tree
If you have ever had a cherry tree in your yard, you know how beautiful it is – with white blossoms and delicious fruit. The cherry tree also grows “suckers” which are baby trees that can turn into bigger trees. So you are set up: you have shade, you have beauty, you have food and you have the potential to make more of everything.
Matches are OK around this cherry tree!
If your employer matches your 401K, make sure to take advantage of that. A match of up to 3% and 5% are common. It may not sound like much, but think of it as you planting one cherry tree and your employer planting another. By the time you retire, you can have the most beautiful yard in the neighborhood.
"Taking out a loan" on the cherry tree
If you take out a loan on the 401K it is kind of like your cherry tree has been infested with beetles. This means that it will continue and grow and fruit, but it is not as strong internally, and you will have to pay a lot more into it than you took out.
Why is this? You are taking out a loan on your 401K (which is taking out a pre-tax investment) and having to pay it back with after-tax dollars. You will pay taxes on the withdrawal when you take it out to use it. This is known as "double taxation." The good thing with a loan versus cashing it out is that it still grows and branches out, but you are essentially paying much more to get what you had before.
Chopping down the cherry tree
Many people invest in a 401K with every intention of keeping the 401K until retirement. But sometimes things come up and I understand that the $70,000 in the 401K seems pretty tasty when times are tight.
But if you cash out your 401K you would you pay a total of nearly $30,000 in taxes and penalties. You have also cut off all potential growth too; you have cut down all of the baby trees as well. Your yard is bear. You have lost your security net. Your net worth has immediately gone down $70,000. You will have to buy a new tree and nurture it for many, many years and invest much more money to get it even close to where it was. You will end up paying more money to make it what it once was, than the money you got out of it when you cashed it in.
A 401K should be a part of the cargo — not the whole Titanic
A 401K is a great investment, but it is not mean to be your whole investment. Imagine if you had everything you owned on the Titanic and it went down (which would be extremely rare, but hear me out…). Even if you made it to a lifeboat you would still be cold and wet. However, if you put one-third of your belongings on the Titanic, the USS Skipper and a navy air craft carrier, you would only have lost one third of your investment.
Consider investing in a multitude of investments or "diversify." Check out other savings options like a money market account, savings accounts, Roth IRAs or traditional IRAs. Think of also investing in stocks in various companies or bonds in the US government.
Swimming with a 401K
Are you living paycheck to paycheck? Do you feel like you can never have enough money to do the things you want? You may need to look at your 401K. It is important to invest, and a 401K is a great way to do it, but it may be that you are investing too much into it. Believe me I know how exciting it is to watch that cherry tree sucker grow, but believe it or not, if money is tight, you may want to limit it to 3% or less until things go better.
Now remember that 401Ks go up and down several times in your lifetime. It is natural for it to lose a lot but then gain it back and then some more when things go better. Don’t panic when it goes down, but continue to watch it. Sometimes a 401K will stagnate and it may be important to roll it over to something that works better.
Don’t ever give up on the 401K completely. It is a great investment. If you invest early and regularly, even a small contribution can turn into over a million by the time you retire. Even if you don’t start investing until your 30s or 40s, you will have to pay more into it, but the rewards are incredible.
Nurture that cherry tree! Make it grow. It makes you wonder if George Washington hadn’t had cut down his father’s cherry tree, he would have had a significant nest egg (wait, maybe he was rich – he must have diversified!)