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Is Borrowing From Your 401(k) a Smart Move?

Is Borrowing From Your 401(k) a Smart Move?

Several years and two home states ago, I recall one of my co-workers telling me about how she was able to borrow from her 401(k) in order to buy a new car (or at least put a down payment on one). She went on and on about how low the interest rate was and, ultimately, how happy she was with her decision. This seemingly good advice stuck with me to the point that, some time later, I decided to give it shot in order to help fund my dream vacation to Tokyo.

While I didn’t know it at the time, it turns out that this move isn’t always as great as it sounds. In fact, borrowing from yourself can actually get to be quite expensive.

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The good aspects of taking out a 401(k) loan

On the surface, temporarily taking money out of your retirement account makes a lot of sense. After all, many of us won’t be retiring for a good long time, so what’s the harm in taking advantage of some of the funds now? Furthermore, if you pay the money back in a timely manner, there are no tax consequences to 401(k) loans, in sharp contrast to the penalties you will incur if you take out money directly.

Another reason these loans are so attractive is that they come at relatively low interest rates. For that reason, it may make more financial sense to borrow your own money as opposed to utilizing credit cards or personal loans that are transparently costlier. Because of these considerations, 401(k) loans can make financial sense and could even be the best option depending on your specific situation. However, there is more to be aware of.

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The rest of the 401(k) loan story

If you compare just the interest rate, borrowing from your 401(k) can seem like a steal. Unfortunately, what you could be stealing from is your future. What’s most borrowers do not account for is how the rate of return on your retirement account will be affected by the absent money. By removing a large chunk of your 401(k) funds, you’re hurting your growth potential. With some accounts earning between 5% and 8% annually, that could really add up — especially if you take a while to pay back your loan.

One more thing to keep in mind: if you fail to repay your loan on time, you’ll not only have to pay taxes on the amount you took out but will also have to pony up a 10% early withdrawal penalty. Similarly, if you leave the employer that hosts your 401(k), you will need to either pay the loan balance back immediately or suffer the withdrawal consequences. For those reasons, if you’re thinking about switching jobs, you may want to look elsewhere for your loan.

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So, is it a good idea?

Honestly, it depends. If your current job is secure and you only plan on borrowing a small amount for a short period of time, there may not be much harm in a 401(k) loan. However, cases in which you’re borrowing for longer or instances in which you’re mulling a change of career might not lend themselves well to this option.

Of course, another big factor is what you’ll be spending the money on. There are plenty of great ways to invest in yourself that might prove more important to you than the potential financial ramifications. To that point, there are definitely worse ways of gaining cash or capital than borrowing it from yourself.

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If you’re thinking about borrowing from your 401(k), the best thing you can do is research all of your options first. Just be sure to consider the long-term impact even a short-term loan could have and don’t jeopardize your retirement for things you need (or, worse yet, only “need”) today.

Featured photo credit: TaxCredits.net via flickr.com

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Published on September 17, 2018

How Being Smart With Your Money Leads to Financial Success

How Being Smart With Your Money Leads to Financial Success

Achieving financial success is not something that just happens. Maybe if you win the lottery or something, but for the average person like you or me, it comes from a series of small steps you take over a long period of time.

With each step, you form a new smart money habit. And with each smart money habit, you build towards financial independence.

So what sort of habits can you form to get on that path? Let’s take a look at smart money habits you can start today to get you closer to a financially independent future.

1. Avoid being “penny wise but pound foolish”

It’s tempting to try saving a couple cents here and there when buying small items. However, that’s not where the real money is saved. You’re putting in extra effort for something that doesn’t move the needle.

You get the most bang when you’re able to cut down on your bigger bills. For example, finding a lower interest rate for your mortgage could save you $50+ per month. And cutting your transportation bill by purchasing a cheaper car or taking public transportation can provide large gains as well.

So, look at your recurring expenses such as housing, transportation, and insurance, and see where there’s wiggle room. It’s a much better use of your time than trying to pinch pennies here and there on smaller purchases.

2. When you want something big, wait

Impulsivity can get you in trouble in most aspects of life. Finances are no different.

It’s human nature to see something and want it right then and there. It starts as a kid in the checkout line at the grocery store, and it continues on through adulthood.

We get an idea in our head of something we want, and it’s hard not to go out and get it right then.

A good example is wanting a new car. Perhaps you’ve had your car for several years. It’s crossed the 100k mile mark. Maybe maintenance is due, and you’re annoyed that you need to replace the timing belt or purchase new tires.

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So, you get the itch.

You start digging around online, and you realize you could trade in your current car for something newer and more exciting… all for a few hundred bucks a month. Then you get obsessed.

Here’s where you have to take a step back.

Your newfound obsession is clouding your judgement. Rather than giving into the impulse, wait it out.

Set a timeframe for yourself. Maybe you come back to the decision three months down the road. See if the obsession lasts.

It might, but often, a funny thing happens. Often, you forget about it. And often, you find that the new car wasn’t a need at all.

The impulse faded. And you just saved yourself a ton of money.

3. Live smaller than you can afford

You finally get that big raise. And you want to celebrate – and why not?

You’ve been looking forward to this forever. And after all, it was all due to your hard work.

That’s fine, splurge a little. However, make it a one-time deal and be done.

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Don’t get caught in the trap that just because you’re now making more money, you should spend more.

Too often, people get more money and feel like they that gives them the means to buy a bigger house, a bigger car… you know the drill. Resist.

The fact is that living smaller than what you can afford is one of the fastest ways to build savings.

But if you constantly upgrade as you begin to make more, then you’ll never get ahead. You’ll just build up more debt along the way and have just as little wiggle room as before.

4. Practice smart grocery shopping

Food… it’s one of the biggest portions of any budget. And if you’re not careful, it can be one of the biggest drains on your wallet.

But luckily, there are a few things you can do to ensure that you stay smart with your money when buying groceries.

Create a grocery budget

Set a strict weekly grocery budget. When you know how much you can spend on groceries, you can then plan your weekly menu around it.

Once you know what all you need, you can go shopping and keep a running tally as you shop to ensure you’re on track.

I tend to do this in my head, rounding for each item. However, writing it down as you go would probably work best for most people.

Make a list… and never deviate

Never go to the grocery store without a list. If you go to the store with a ballpark idea in mind, you don’t have a true ide of what you need.

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You’re not well-researched. You don’t know what the sales are. As a result, you’re going to make decisions on the fly.

These impulse decisions will lead to overspending, which will derail your grocery budget.

Eat before going grocery shopping

It’s also important to eat prior to going to the grocery store. Hunger is a powerful force.

If you’re shopping on an empty stomach, everything is going to look good. In particular, you may find a lot of ready-made, processed snacks will look enticing.

After all, you’re hungry now and that food is easily available. So subconsciously, you may lean towards those items.

Unfortunately, not only are those items typically less healthy, but they’re likely more expensive. You pay for convenience.

However, when you eat prior to shopping, then you’ll shop with a clear mind. Your hunger won’t cloud your judgement, influencing you to make poor decisions like a cartoon devil resting on your shoulder whispering in your ear.

This makes it much easier to stick to your grocery plan.

5. Cancel your gym membership

Now that you’re all set on your food, it’s time to get smart about managing your budget in terms of physical fitness. And let’s begin by avoiding the gym. The gym bill, that is.

The average gym membership costs around $60 per month. That’s $720 a year.

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Yet, two out of three gym memberships go unused. That means two-thirds of people who have a gym membership are literally giving away almost a thousand bucks a year. It’s crazy!

I recommend seeking an alternative. One good alternative is to look into fitness streaming services.

Streaming services allow you to stream hundreds of workouts like Insanity and p90x, right in your own home for around $10-20 a month. That’s $40-50 less a month than the average gym membership.

Of course, then there’s the free option. The internet is full of free workouts that you can do on your own with minimal or no equipment.

For example, there’s the Couch to 5K program, that I personally used a decade ago to ease myself from couch potato to running my first 5K race. If I could do it, anyone could.

Then there are free resources like reddit that have limitless information on workouts. The Fitness subreddit has done all the research for you, populating workout tips and detailed workout routines for anyone to use in their wiki.

There are several routines that require no equipment. And you can join in on the subreddit to become part of the community, making it easier for those seeking comraderie and encouragement in their fitness goals. All for free.

It’s baby steps… And baby steps can start now!

I’ve never met anyone that can’t stand to be a bit smarter with their money. And on the flip side, anyone can get smarter with their money. But remember, it doesn’t happen all at once.

Begin by fighting your impulses. Prepare for the week and be smart at the store. And cut monthly expenses like gym memberships that are overpriced and you probably aren’t getting your money’s worth out of anyway.

The devil is in the details. And the details can change your lifestyle and prep you for a financially independent future.

Featured photo credit: Unsplash via unsplash.com

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