The Writers Coin

Trent had a reader ask him a question that got me thinking quite a bit the other day. Basically, Wayward wants to know if it’s OK to stop contributing to his 401(k) and if he should put the money he was previously putting into it into a different account.

The problem? His company, as are many others during these difficult times, is no longer offering their employees any matching. That means you’re not getting the biggest perk of all of a 401(k): free money.

Matching? We Don’t Need No Stinkin’ Matching!

Umm, yes you do. As frequent readers know, I’m not a big fan of 401(k) providers—I think most of them suck. Why? Let me count the ways:

• Limited Options: Their menu is very limited and if you want to lobby for change, it will take a long time to get it done—if it happens at all. Think of as being in jail and complaining about the food—what are you gonna do but eat what they serve you?
• High Expenses: Why wouldn’t they charge you more? They’re the only game in town, so they can charge whatever they want because they know you want to get your hands on that “free money.” It’s kind of like the ridiculous prices of candy and soda at the movies. There’s no competition so they can charge whatever they want.

Something about that whole attitude of “hey, we’ve got you where we want you so we’re gonna fleece you” just doesn’t sit well with me. So if I were in Wayward’s shoes, here’s what I would do:

• Open a Roth IRA: Trent also recommended going this route, and I think it’s a no-brainer. Having a Roth IRA and a 401(k) gives you added flexibility (as this “oh so early” post of mine illustrates—I’ve come a long way) when it comes time to retire. I have mine in several places, but the best place to start is Vanguard: cheap index funds baby.
• Stop contributing as much: Wayward was originally contributing 20% of his paycheck to his 401(k), to which I say “Whoa!” That’s great that you can afford to set aside that much of your paycheck, but with the matching gone, I would seriously cut this back. How much? How about trying to fully fund the Roth you just opened. That’s $5,000 a year. If you can fully fund it and leave the rest in your 401(k), you are home free.
• Check your allocation: Now that you have a Roth, look at the funds you want to own in your entire retirement portfolio and see where they are cheapest. If you you can get the same fund in your Roth and your 401(k), odds are it’ll be cheaper over at Vanguard than with your 401(k) provider, so pick the one that is ripping you off “the least” and buy that one with in your 401(k). What you’re trying to do here is minimize your fees.

Am I missing any other tips for people in this situation? I know that the drumbeat out there is to contribute as much as you can to your 401(k), but under certain circumstances it’s worth considering the other options that are out there.

Oh and if you still get matching I would still push for opening the Roth—flexibility is a beautiful thing.

Nothing.

So far I have done nothing. I’m still impressed with how cool I’ve been throughout the whole thing, especially with all the unrealized losses I have. Granted, I’m young and only started investing a few years ago—so I’m not losing nearly as much as other people are—but it still doesn’t feel good. One of the things that has kept me so level headed is everyone else. When everyone else talks about the markets and how they’re doing and what to do and the panic surrounding the whole thing, I just want to get up and leave the room. I hate talking about things when everyone and their mother is yelling about it. I don’t know what it is, but I have an aversion to talk about whatever is the “it topic” of the moment.

When I was in school and there was a test, people would always walk into the class and start talking about the material. After studying for hours the day before, the last thing I wanted to hear was all of that regurgitated back to me minutes before the test. I hated it. That’s kind of how I feel about all this, even though that’s what I like to read/write about for this site. It’s kind of like when you really love a band that no one knows about and then they go mainstream and everyone knows about them. You kind of stop caring as much because they aren’t your little secret anymore.

Anyway, back to the lecture at hand—the markets. I haven’t done anything. I haven’t taken my money out of the market, I haven’t changed my allocation, I haven’t even bought anything new (except via my 401k). But that’s the one thing I’m looking into: buying more.

I invest exclusively in my Roth IRA, and since I’ve already contributed to the limit for this year, I have to wait until next year to put more money in. This might be a good thing, I don’t know. But I really am getting the itch to dump a good amount of money into the market right now. The inevitable recovery, no matter when it happens, will be a great boon to those that realize this.

But if I had some cash on hand and a little room in my Roth, I would probably buy some more huge chunks of my Vanguard Index funds (US large cap, mid cap, and international stocks) and then watch their REIT index fund like a hawk. I meant to put money in there for a long time though right now I’m glad I didn’t, it has tumbled pretty hard—now may be the right time.

But I have to be honest, there is a certain sense of freedom knowing I can’t do anything until Jan 1. I can plot out a million ideas and things, but I can’t put them into action until then (unless I were to invest in a taxed account). It’s kind of like the trick of waiting a few days before buying something big (like a Wii or an iPhone)—usually it’ll fade away and you’ll have saved your money. Usually.

Hopefully by Jan 1 I’ve burned through all the bad ideas and only the good ones will be left. Then I’ll pounce back into action.

[This post has been included in the Money Hacks Carnival over at Sound Money Matters. Be sure to go over there and check out the other great posts]

Earlier this year I was part of a discussion somewhere online about how and when to contribute to a Roth IRA account. There were two groups of people arguing their own points — since all the investing I do is in my Roth, I was eager to be a part of the discussion. Each side was very vocal about defending their opinion with a host of arguments and points, which was fun. One side felt that it was best to contribute everything you’re allowed to contribute ($5,000) at the start of the year in one lump sum and not worry about it until next year. The other group, meanwhile, argued that you should practice dollar-cost averaging to avoid any huge drops in the market.

Let’s take a look at the two sides, their arguments, and see which one I subscribe to:

One Lump Sum

The argument here is all about convenience and uses some assumptions about the stock market. For one, it’s much easier to do this once a year. As long as you have the money (which is one strike against this theory, since a lot of people don’t have $5,000 laying around), you can just send it to your broker, buy what you want, and be done with it. “Set it and forget it.”

We all know that compound interest is a fantastic thing, and to some that means the sooner you have the money “in play,” the quicker it’ll compound. Which is true, as long as the market goes up in that particular year (which it won’t always). So if the market goes up, you have more money growing. That’s another assumption behind this choice: that the market will gain 8% per year (which, on average, it does).

Pros: Convenient, quick
Cons: Expensive, assumes market will go up

Dollar-Cost Averaging

The idea here is to take a set amount of money and invest it throughout the year. The theory is much more robust than that, but the idea is that you ride out any huge changes in the market this way. If things go up during the year, you’ve been putting money in the whole time, so you’ve done well. If the market goes down, then you’re buying stock the whole way down and getting a lot of it on the cheap, so you’re doing well too. This is obviously the conservative, safe approach—which for a lot of people is the way to go when you’re dealing inside your retirement account.

The bad thing about this is that you have to take action several times a year, which isn’t the most convenient thing.

Pros: Rides out any ups and downs, “safer”
Cons: Requires several actions per year, won’t grow as much on an up market

My Take

I’m a huge fan of dollar-cost averaging in general, so that’s the side I’m on. It’s also a better fit for me because I’m a micromanager—I check my accounts all the time and this gives me something to do throughout the year, especially when the market is down. When that happens, investors psychologically feel like they have to do something. I’m in this camp, and with my obsessiveness it’s a natural fit.

It also helps me stay true to my allocation throughout the year. Every time I put more money in, I can contribute between all my investments to make sure none is growing or dropping faster than the others and my allocation stays where I want it to.

The reason I’m bringing this up now is because I just sent in Round 2 of my Roth contributions this year. The market has been down and right now I’m buying low. Right away I was reminded of this discussion and it hit me: if I had put all my money in back in January I’d be screwed. I wouldn’t be able to do anything right now.

What side do you fall on? Let’s start a nice, clean argument here…

I’ve been contributing (fully) to my Roth IRA account for a little over three years. At the end of this year, I’ll have around $16,000 total in my Roth IRA. Now that M and I are married and our current lease is up in August, we’re thinking about buying a place. So we’re doing all the preliminary exploration that everyone does when thinking about buying a new place. And that means figuring out how much money we have to put towards a down payment.

For the uninitiated, a bigger down payment means a few things (and anyone else who’s done this before, please feel free to chime in), but the gist is you can afford a nicer place for a smaller mortgage at a lower rate. So you want to have as much money as you can to put down. And these days some lenders won’t even give you a loan if you can’t put down 20% of the total cost, which for an average place in the Chicago area is somewhere around $55,000.

So as we tally up how much money we have to put towards this huge expense, I naturally started thinking about my Roth IRA. Why? Well, we don’t have $55,000 laying around. Turns out that one of the conditions under which you can withdraw money from this account (without a penalty) is if you’re putting it towards your “first house.” There is a lot of literature out there about borrowing from your 401(k) to pay bills (it’s a bad idea), but this is a little different. The rules are also a little different.

I researched the hell out of this one and came up with all the different rules and technicalities behind putting some money from a Roth IRA towards a first home, and I was still a little confused. So it was great to find Five Cent Nickel’s post about doing this very thing. He’s already done it and the comments have sparked a great debate about whether or not this is a good idea.

Turns out he did what I’m thinking of doing myself: putting money away into a Roth account with the idea that, if I need that money for down payment help, I can use it. Instead of putting it away in an ING account earning a fixed 3%, I have it in the market, which is a little riskier. It’s going in there with the idea that it’ll be funding my retirement, but it’s also giving me the flexibility of helping me out with my down payment if I want to make that call.

So part of me wants to take advantage of all the saving I’ve done over the past few years to get be as responsible a home buyer as we can (i.e. put as big a down payment as we can). When I include this money in our “for down payment” pile it means we come pretty close to 20% on the “average” house we would want. Without it, we’re not even close. So it’s basically a choice between not raiding the Roth IRA account or buying a house without putting down the “responsible” 20%. What’s a first-time home buyer to do?

The other part of me is firmly against this. Interrupting the magic of compound interest is the last thing I want to do, especially since I’m still in my twenties and I want that money to sit there and grow for as long as I possibly can. I can tell myself that I’ll fully contribute to the Roth from here on out so it won’t matter much. Or that I’ll have a higher salary in the future. Or a whole bunch of other stuff that ignores the idea that I’m taking money that was meant for M and I to have a comfortable retirement and putting it towards a house that we probably won’t be living in 5–10 years from now.

There is, however, a third option. We could rent for another year and turn up the savings with the goal of saving up even more than 20%. Then we’d be in the driver’s seat and we wouldn’t be touching our retirement accounts. This is a very real possibility since we haven’t even started looking, gotten our credit scores, or any of the preliminary steps to buying a house. So far it’s just been talk. We feel like we just got married (we did, two weeks ago) and not having to worry about all that stuff is great — we finally have time to just chill out and enjoy our summer. So part of me wants to wait and not embark on such a huge project just yet.

But housing prices are good right now. Interest rates are low. There may not be a better time to buy than right now.

What do you think? Any advice from the home buyers out there?

Update: We are buying our first place! We didn’t use up any of our Roth and we didn’t go with a piggyback mortgage.