Playing a little Devil’s Advocate–and someone asked me about this–why do we have to stick it out? What if the cost of pulling it out of your 401k and putting it in another idea (while continuing to reap the benefits of buying low and still contribute, but take out your principal)? True, you may not have known that hindsight would be 20/20, but an interesting idea to think about…

I’m not moving personally, but something to think about still. Good post! -Hank from Mib

When we look at the numbers, it becomes clear that it would be very difficult to overcome the tax penalties tied to early withdrawals.

To review,

• 100k after 41% stock market drop = 59k
• 59k after 10% early withdrawal penalty and 25% tax bracket = $38,350

The first $41,000 lost is unavoidable, due to a downturn in the market. But the next $20,650 lost would be self inflicted.

In order to recoup the $20,650 lost to taxes, you’d need to earn a 53.8% one-year return on your remaining $38,350 or a 9% return—five years in a row.

Of course, these returns ignore the impact of taxes. You would need to earn an even higher annual return or invest even longer to make up for taxes.

In order to earn a 9% return, you would probably have to invest in the stock market again or get involved in a business venture which would involve a fair amount of risk and time.

And if this was even possible, then why wouldn’t one take this route before the stock market had a bad year? (The S&P 500 finished last week down 40.6% for the year.)

If you can’t stomach further stock market exposure, or if you have a lot of debt, a better strategy would be to stop future contributions and redirect that money to paying down debt or into safer investments.

Just resist withdrawing that money early—the penalty is simply too severe for most investors to recover from.

Recently, one worried reader asked the following:

It’s October 11, 2008. A time of recession, bailouts, economic collapse, and massive government debt. I am 54 years old. My wife is 46. I have closed out my stock funds in the 401k and have it sheltered in a money market. I am thinking about pulling money out of my 401k to pay down my mortgage.

I think I will get a greater return on my money than I will by being in just a money market fund. the mutual funds were losing lots of money. One of my funds was losing 41% of it’s value. We also have a lot of credit card debt. I owe 18,000 and my wife owes 30,000. Plus she owes $20,000 in student loans. Plus I have a son in college.

I know that in normal times pulling money out of a 401k wouldn’t make sense, but now the economy is about to collapse I think that it does. I can make a guaranteed $130000 in saved interest if I do that. I don’t think the stock market will be back any time soon. I favor paying down the mortgage over the cards because it will insure I won’t lose my home that way. Then I can work on the cards. I think our jobs are pretty safe. We just are overloaded with debt. I am only 3.5 years along on a 30 year mortgage.

I haven’t done this yet, but I think it makes sense. It looks like just leaving the money in place will be a losing proposition. They say even money markets aren’t safe any longer.

What do you think? -Concerned

 

Yes—the stock market isn’t pretty. Last week the S&P 500 experienced a 18.2% drop and was down 38% for the year. Nerve wracking? Certainly. But the following Monday (10/13/08) the S&P 500 gained 7.5% back only to lose it again. Stocks can be extremely volatile.

Yes—earlier this year would have been the perfect time to have switched from stocks to something safer. But, how would you know when to jump back in? Successfully timing the market is more difficult than most people think. The vast majority of professional investors fail to beat the market.

Bailing on the market now and handing the government half of your remaining savings would not be a good idea. An early withdrawal now will cost you dearly. The withdrawal will be taxed at your tax bracket plus a 10% early withdrawal penalty.

For example, the 41% drop would have turned a 100k balance into 59k. An early withdrawal would then trigger a 10% penalty tax, added on top of your tax bracket, leaving a mere $38,350 for debt repayment. (assuming the 25% bracket)

That’s a heavy, guaranteed price to pay just to avoid the ups and downs of the stock market or the low returns of a money market fund. Instead, a better strategy would be to take a step back and then invest according to a written and well thought out asset allocation plan that relies on index mutual funds and is compatible with your tolerance for risk.

A good asset allocation plan will diversify your investments, providing stability during rough periods (like the present) in the stock market. You should work with a professional fee-only financial planner to develop your investment strategy, but there also are many excellent books on investing successfully. The Coffeehouse Investor and The Four Pillars of Investing are two of my favorites (read them in that order too).

Paying down debt is always a good goal

I am a big supporter of short mortgages, but mortgage prepayment needs to be part of a bigger strategy to avoid debt in all of it’s forms.

Right now, your biggest challenge isn’t stock market fluctuations or a downturn in the economy, the challenge is changing your spending habits. You and your wife need to sit down and work out a written budget where every dollar has a name. The budget needs to cover all of the essentials: mortgage, utilities, food, insurance, & minimum payments.

Then, set aside a thousand or more towards an emergency fund. It’s essential that you have some money to fall back on because you really need to tear up your credit cards. Once you are debt free, you should work towards an emergency fund equal 3-6 months worth of expenses.

Next, take what’s left over each month and put it towards the $18k credit card (or the smallest balance if it’s spread across several cards). You want to throw everything you can at this debt to make it disappear fast. Once it’s repaid, repeat the process with the next smallest credit card debt.

To turn this ship around faster, one or both of you need to get a temporary, part-time job. Life is going to be rough for a few years, but the inconvenience will be temporary. After all, you’re making an investment in your future happiness.

You also might want to consider talking to your son about shouldering more of the financial responsibility for his college education. Helping with college expenses is a great goal, but you won’t be doing anyone any favors if you drown in debt to spare him the indignity of working his way through school.

Retiring debt is the first step to a happy retirement

If you don’t get aggressive right now and show debt the door, you’re going to be looking at a lifetime of working—into your seventies and beyond. Retiring is next to impossible when you’re servicing debt.

For more information and inspiration about ditching debt, I’d recommend you tune into Dave Ramsey’s national radio show. He’ll put you and your wife in the right frame of mind to begin working for yourselves instead of working to feed the credit cards.

P.S. Don’t fret about the economy. It’s slowing down right now and life will get a little rough for some people. But the downturn will be temporary; it always is despite what the talking heads on TV tell you. The best way to prepare is to (1) pay down all of your credit card and car debt, (2) fund a large emergency fund, and (3) then keep developing your professional skills. Businesses are always interested in potential employees that possess valuable, in demand skills.

I know you are busy, so if you don’t have time to continue reading now, please just scan my very quick, bulleted summary. It’ll be painless—I promise.

Even in America, big dreams take time

Like most good things in life, houses take time. Time to build, time to save for, and time to pay off. Although my wife and I feel a sense of pride every time we walk into our new home, many people now see their new homes as a prison because they bought before they were ready.

A few decades ago, families would build their own home with cash or they would borrow money for a few short years. Today, thirty-year mortgages have become the norm and some desperate people have contemplated longer contracts!

When you take on a mortgage, the bank owns the house. You are simply a glorified caretaker until the loan is repaid. And the price of borrowing can be very heavy indeed, both in dollars, but also missed opportunities. A mortgage can keep you trapped in a job you hate, stuck in a location you’ve outgrown, or become an anchor around your neck as it develops costly problems.

My wife and I feel this long term commitment is detrimental to one’s health and pocketbook.

Make your home a blessing

In order to ensure your new home is a blessing instead of a curse, please take on a 15 year mortgage instead of a thirty year contract. You’ll own your house sooner, cut your interest expenses in half, and you’ll be able to upgrade to a more expensive home if you wish. A thirty year mortgage will double the money you lose to interest!

Start with a starter home. Buying a modest home is okay—you won’t need to stay in your first home indefinitely. In fact, most people don’t. However, if you do buy an expensive home first, you just might be stuck for years to come.

Thanks to the nature of interest and big balances, the first few years you’ll hardly pay down any of your debt. On a 30 year 220k loan at 6%, you’ll have a mortgage payment of $1,320, but $1,100 of your payment will go to interest!

You’ll also be responsible for homeowners insurance plus another $200 in rent to the government (property taxes) each month. You’ll also be responsible for maintenance and bigger utility bills.

By the end of the month, you’ll have paid out $1,700-2,000. But only $200 of it will go towards paying down your mortgage. Translation—be prepared to be in debt for a long time.

Surely rent plus utilities is the less expensive option?

No wants to hear this, but…

Your down payment will also play a big role in your quality of life. I know down payments have fallen out of fashion, but they’re making a come back as the housing market softens and no down payment “home owners” increasingly have trouble making their payments.

A down payment of 20% or more makes a statement about you. Banks know that people who make down payments are less likely to default. That’s why you’ll pay private mortgage insurance (PMI) if you lack a 20% down payment.

Yes, I know some lenders are eager to lend you your down payment! But they’ll charge a hefty interest rate for the risk, which will just make your house more expensive!

Most of all, your down payment will tell you and your wife something important about yourselves—you’re serious about buying a house, you’re willing to make the sacrifices required, and that you’re prepared to buy your first home.

Choices, choices, choices

I’m not sure what type of house you have in mind, but there are a few options: new, old, or build your own. I suggest you avoid the latter in the strongest words possible. Our building adventure was a nightmare as many owner builders discover.

Many people choose a new home because they’re more energy efficient, require less maintenance, and they have that new car smell.

Older homes, however, often are closer to work, possess more character, and are located in established neighborhoods. The decision really depends on what you want and need in a home. Just make sure you have a thorough inspection done. Costly, unexpected repairs will decimate your savings.

And don’t kid yourselves, your house will need repairs: windows will break, kids will clog toilets, roofs will wear thin, and appliances will break. Count your blessings if no pipes burst or tubs overflow, because water damage is the worst.

Dealing with the unexpected

I’m sure you’ve heard about the importance of a rainy day fund or life happens fund. As a new home owner, it’ll be essential that you have savings equal to 3-6 months of expenses set aside. When your water heater breaks or your child accidently throws a bat through your window (done that), you won’t have to use credit cards to pay the bill.

And speaking of bills, you’re going to have lots of them. Water, sewer, trash, and lights. A gas bill will probably find it’s way into your mailbox too. Your county will be waiting with outstretched hands, they’ll be reaching deep into both of your pockets and probably your wife’s too! Don’t underestimate the burden of property taxes, as a renter, you’ve been sheltered from rapid increases—you’ll have no such luxury now.

Speaking of luxuries, most new home owners furnish their homes with several. From new blinds to new paint to new furniture–all financed on credit–you’ll be tempted. Just remember, there is nothing like the sweet feeling of sleeping on furniture you already own in a house that you almost, or will soon own.

Final thoughts

I’m sure I’ve left a few things out, but I wanted to keep this letter to a manageable length. I’m even more certain that you probably disagree with some of my advice and that’s okay. Some of my suggestions aren’t very popular these days.

I just want to make sure you move forward fully aware of the trade offs you’re making. We all face trade offs; unfortunately, most of us forget this when making exciting, life-altering decisions.

P.S. I know family has offered to help. Just remember that the borrow is truly slave to the lender (Proverbs 22:7). Loans have soured friendships and destroyed family bonds. Your mortgage will be burden enough, don’t make your life more complicated than it needs to be.

The best time to buy a home is when you have the money.

A quick summary

• Pay off any debts (except low rate student loans) before buying a house
• Wait until you have your down payment, closing costs, and an emergency fund equal to 3-6 months of expenses
• Don’t borrow money from family
• Get a 15 year, fixed-rate mortgage
• Decide on how much money you are going to borrow before house hunting
• Buy a starter house

The following post is courtesy of Australian blogger Tehn Yit from the Cheap-as-chips.

Impulse buying is one of the human behaviors that I really hate. Why? Because I typically end up buying an item that I neither need nor is it suitable for the task.

It is human nature that when we see something desirable, we will want to buy it, own it or get access to it; but at the end of the day, we probably could do without it. The money could be better spent elsewhere.

So I was thinking on what I can do to avoid impulse buying and came up with a list of 5 items that help limit, or perhaps stop, impulse buying.

1. Make a shopping list and stick to it. Having a shopping list forces you to think about what you want before you are actually in the shops. If it is not on the list, you don’t buy it.
2. Only carry enough cash to purchase what you are going to buy. I have found that the items that I purchase on impulse are usually much more expensive that what I intend to purchase in the first place, so by having the correct amount, I am not able to purchase anything more.
3. Look at the items that are not at eye level. Have you noticed that popular items on the shopping shelf are at eye level. They have been strategically placed there so that the shopper will notice them before the other less popular, but more affordable brands.
4. Don’t carry a credit card. Impulse buying is also in effect when you are not shopping. Say you are walking the street and noticed something that you really want but don’t have enough cash. Most will just charge it to credit card. If you don’t have a credit card, you can’t charge it and therefore no impulse purchase.
5. Watch and listen to advertisement free TV or radio. Shoppers are conditioned to purchase certain brand of items and the conditioning is performed via adverts on the TV, radio and print media. By not exposing yourself these kinds of media, you avoid being conditioned. Some of my friends call this brainwashing.

I have found these 5 items work with varying degree of success; it is highly dependent upon the environment you are in at the moment. Human nature is extremely difficult to control, it is who we are and what we do. All we can hope for is to minimise the amount of impulse buying.

Tehn Yit blogs on Cheap-as-chips. It’s a peek into the average family man’s thoughts on saving money and getting ahead financially.

Photo by olivier hodac

Marriage, like most ventures, requires effective communication for success.

My wife and I met under peculiar circumstances, so we knew from the start that we had a lot to talk about.

Early on, we invested time talking about our values, beliefs, and approach to life. We didn’t want our marriage to become another divorce statistic.

Today, money disagreements are at the root of many failed marriages. Many of these disagreements could have been avoided with a little financial education, open communication, and agreeing on key values and goals before getting married.

Opposites attack attract

Before we met, we’d handled our money quite differently. My wife took an easy come, easy go approach, which contrasted painfully with my thriftiness. Of course, I really was only thrifty so I could spend all of my money on my hobbies, so neither of us were planning for the future.

Initially, I was concerned that our conflicting money behaviors might make us incompatible, but we soon realized we shared the same goals and values.

Once we discovered that we shared the same religious beliefs, dreams, goals, and life strategies, adjusting our money behavior was simple.

Increase your odds for success

Sharing the same religious beliefs and values is the foundation of a strong marriage. It is difficult to become one when a couple’s fundamental beliefs differ wildly. Values will inevitably differ slightly, but big differences can and probably will lead to arguments, money disasters, and more.

When life gets busy or unpleasant, sharing the same dreams and goals will help you get through the challenges. Getting out of debt, saving for a house, or going back to school requires sacrifices from both spouses.

Sometimes people’s core beliefs are compatible and they even want the same things in life—they just don’t agree on the strategy for getting there. We’ve all heard stories about the spouse addicted to gambling or the serial entrepreneur who is constantly in debt. Disagreements over risk, debt, and career strategies can leave both spouses unhappy, teetering on a financial precipitous.

Looking back at my own circumstances, poor communication has been at the root of our biggest marital frustrations. Fortunately, the solution simple—keep talking things through until we understand each other. Confusion is inevitable, but it doesn’t have to be about the big stuff.

This post is part of a series on My financial awakening: A life turned upside down

Photo credits: aturkus, demi-brooke

When you buy a burger, you can’t use that money to rent a movie, pay down debt, or invest. And when you sit down to watch a movie, you’ve traded your time and money for two hours of entertainment.

Continue reading this guest post at Cheap as chips.

    avoid debt,

  save now,

     save enough,

        minimize expenses,

    own everything;

money will then be your powerful ally

instead of a crushing burden.

This post was part of Liz Strauss’ The 25 Words of Work / Life Wisdom Writing Project.

A: Although the stock market has outpaced inflation in the past, the stock market’s returns are too volatile to only invest in the market.

In the past, investors had few options for shelter. Today, however, the government sells TIPS and Series I bonds which compensate investors for inflation (ironically, inflation directly caused by the government).

Although you can directly invest in these government bonds, most people would be better off investing in an inflation protected mutual fund like Vanguard’s Inflation-Protected Securities (VIPSX).

Q: You write about getting ahead as if it’s so easy. Most of us will never end up rich because the deck is stacked against us. -Skeptical

A: I don’t mean to make building wealth sound easy. It is simple, but far from easy. Spending less than we earn is a simple concept, but you won’t find many people who enjoy spending less, so they can invest more.

And while the majority of the world’s population still labors under oppressive governments and has little capital with which to work with, if you’re reading this, the odds are you live somewhere where freedom and opportunity abounds. You just need to set your mind to it.

That’s not to say that we’ll all end up rich. After all, rich is a relative term. You might not be rich compared to a multi-millionaire, but even the poorest people in the western world enjoy luxuries unimaginable to royalty just one century ago.

If you’re still skeptical, check out some of the personal finance and wealth building blogs where average, regular people are detailing their journeys to their own financial success.

A few blogs worth checking out: Frugal Dad, Mrs Micah, MoneyNing, Moolanomy, My Investing Blog, plonkee money, & The Wisdom Journal.

If you have a financial question, contact me to have it answered on the site. Please be sure to state whether your name can be listed, or if you’d like to remain anonymous.

Photo by Stefan

With the cost of energy rising and the value of the dollar dropping, frugal choices are becoming increasingly important. Here’s how 55 bloggers have used their frugal instincts to:

• plan for success
• handle credit
• put food on the table
• manage gasoline consumption
• practice the art of shopping
• juggle bills
• lawfully avoid taxes
• enjoy frugal activities
• make frugal calculations
• Tie the knot without getting tied up in debt
• practice frugal habits

Planning for success

• Debtopedia’s How to Avoid Debt With Good Budgeting
• Pasadena Financial Planner’s Living Expense Tracking Methods
• The Family Wallet’s Fun Ways to Teach Kids How to Save Money

Handling credit

• Debt Smack Down’s Ditch The Credit Cards To Save Money
• The DebtFree Playbook Blog’s Credit Cards - Get Deal Wise

Putting food on the table

• Cheap Healthy Good’s 20 Cheap, Healthy Dishes Made From 10 Pantry Staples
• Earthlier Happy is the Rose Distilled’s Frugal Food - Cost Analysis of a Lasagna
• Chief Family Officer’s Not as good as homemade, but better than fast food
• The Personal Financier’s How Shopping for Groceries Online can save you Money As well As Time
• Greener Pastures’s Eating Healthy Without Being Wealthy
• LivingAlmostLarge’s Hillbilly Housewife $70/week
• Save and Conquer’s The Deceptive Grocery Shrink Ray
• Squawkfox’s Recipe: How to Make Authentic and Low Fat Hummus

Black gold

• Funny about Money’s How higher gas prices save money
• Debt Free’s Buying a New Car to Save Gas – Does it Make Sense?
• Penny Pinching’s 26 tips to save money on gasoline
• PersonalFinanceAnalyst’s Get a break from the pump by improving gas milage
• Money Smart Life’s Saving 15 Cents a Gallon on Gas - Plus Doubling Our Savings at the Pump
• The Sun’s Financial Diary’s MyGallons: Save Money on Gas?
• The Sojourner’s How We Are Saving on Gas

The art of shopping

• Fabulous Finances’s The right way to shop for quality without going broke
• Natural Mom’s Talk Radio’s Natural Product Bargains Can Be Found
• Frugalous’s 3G iPhone? Voice of Temptation meet Voice of Reason
• Broke Grad Student’s Is the iPhone 3G Worth It?
• Financial Ramblings’ Find The Lowest Prices Online With Channel-Specific Discount Links (Huh?)
• Think Your Way to Wealth’s The Irony of the 3 Day Only, 50% Off, Salebration!
• Frugal Homemaker Plus’ Why not? You can afford it!
• Our Fourpence Worth’s Booking Flights Early Could End Up Costing More
• Student Scrooge’s booking air travel? a tip to maximize cash back
• MoneyCrashers’ How To Save Money In the Big City
• Cash Money Life’s How Much Should You Tip? Divide by Six
• Frugal Babe’s Baby Clothes - You Don’t Need Much
• Out of Debt Again’s Remove Wrinkles - Like Magic!

Juggling bills

• Art of the Coupon’s Taking a Look at Eliminating Monthly Bills
• Are You Going To Be This Way The Rest of The Time I Know You?’s All I Had to Do Was Ask!

Lawfully avoiding taxes

• Money and Values’ Pay commuting, medical, and/or dependent care costs pre-tax, and save money for both you and your employer!
• My Dollar Plan’s Tax Savings: How to Deduct Mileage on Your Personal Car

Frugal past-times

• Within My Means’ Another Frugal Weekend
• Laura William’s Musings’ Around the Homestead Today…
• Free From Broke’ New York State Empire Passport - Summer Saving Series #14

Frugal calculations

• Uncommon Cents’ A New Bike Won’t Make Me a Better Cyclist
• Blueprint for Financial Prosperity’s Cost Benefit Analysis of GPS Units
• Value For Your Life’s The Undeniable Pet Insurance
• Stop the ride!’s Maybe I’m Just Cheap
• Not Made of Money’s Should You Repair or Replace That Old Appliance?
• Dollar Frugal’s Americans Smarten Up
• This Wasn’t in the Plan’s What Happens When You Already Do What You Should?

Tying the knot without getting tied up with debt

• The Digerati Life’s Control Your Wild Wedding Costs! Set Up A Wedding Budget
• Daily Money Hack’s Wedding Tips: Cost-Cutting Invitation Ideas
• Northern Cheapskate’s A Wise Wedding Registry Could Bode Well For Your Marriage
• FreeMoneyFinance’s Two More Ways to Cut Wedding Costs

Frugal habits

• The Happy Rock’s Embrace Your Diurnal Cycle/Sleep When Its Dark
• Frugal Fu’s Down and Dirty: DIY Plumbing Tip
• Amateur Asset Allocator’s Frugal Ways To Lose Weight
• Debt Smackdown’s Discipline Yourself to Spend Less

For more frugal tips, check out next week’s festival at Antishay Ventenne. You can also find more frugal goodness hosted here: Festival 109 & Festival 122.

If you’ve found this collection of resources useful, please make sure to stumble, digg, or bookmark it below.

That’s a trade off we’re not willing to make.

Many people view their retirement balances as the solution to their situation–working an unpleasant or demanding job–only to fall short of their goal. Instead we’ve decided to focus on eliminating debt before heavily investing for our retirement.

We might end up with less money, but eliminating these fixed costs will free us to work when and where we want to.

Of course, we could work more now so we’d be able to rapidly pay down debt and invest more. But this would negatively affect our quality of life for us and our children.

That’s another trade off we’re not willing to make.

So what are we missing out on by focusing on our mortgage instead of our retirement? Well, we are getting our full 401k match, so we’re saving almost 10% of our gross income. Perhaps we’re not missing out on much.

Ditching debt

Debt is an obligation and as such, it’s a claim on the fruits of our labor. Depending on how much debt one has, debt even has the power to push people into jobs they hate!

That’s why we’re paying off our 30 year mortgage as quickly as possible.

We’ll be avoiding more than two decades’ worth of interest payments. And once we’re free, we’ll still have the opportunity to benefit from compounding interest.

We might even come out ahead if the stock market returns less than pre-paying our mortgage saves us. Higher or even positive returns are not guaranteed, despite the markets upward trend.

How have you chosen to balance life? Are you working towards an early retirement, or are you trying to enjoy the best of retirement today?