Comments on: 401(k) Loan: Friend or Foe?

By: Michael

Michael — Tue, 29 Apr 2008 17:41:35 +0000

Of course! Any time. Notice that the 8% is a post-tax rate and the 4% is a pre-tax rate. In addition, the possible 4% you could have earned from investing in cash doesn’t come from your paycheck; it comes from the bank. On the other hand, the 8% “return” from your loan isn’t really a return; it’s really a payment by you to you. You haven’t earned any money this way (other than not having to pay the interest to borrow similar money from a bank.)

By: George Bush

George Bush — Tue, 29 Apr 2008 15:09:32 +0000

You are right about market timing – it could just as easily have gone the other way. Had the market went up 30% during that time, I would have lost out, But I don’t believe I would have done any better with the cash option – the return on the cash option may be 4%, the interest rate charged for my loan was closer to 8%. I effectively locked in a gain of at least 8% for my money in the 401k. For long term planning, I am happy with a return of 8% in my 401k.

Lots of pitfalls with this strategy that you mention including the potential of losing your job, or what I think many people might do, – cut back on their regular contributions so that they can pay back their loan, but if you avoid these, then I think it is a relatively decent option to borrow small amounts of money rather than taking out a non-deductible loan and pay interest to someone else.

THanks for letting me share an alternative view.

By: Michael

Michael — Tue, 29 Apr 2008 12:53:15 +0000

@ GB: I’m glad it worked out for you. Of course, the market could have just as easily gone up during the time your money was out of the market, which would have caused you to miss out on significant gains. You effectively timed the market and did so successfully. But if you (or anyone else) tried to do so 10 times, I doubt you’d be happy with the results even give times.

The fact that you borrowed money is tangential to your successful market timing – you could have achieved an even better economic result by simply selling out of the market and putting your money in the cash option of the 401(k). But that’s just hindsight of course.

Thanks for sharing your experience!

By: George Bush

George Bush — Tue, 29 Apr 2008 02:49:02 +0000

I think 401k loans are fine. The alternative is to get a loan from a bank that I have to pay back to someone else with after tax dollars. When I took out a 401k loan for a car, I paid the loan back in addition to making my usual 401k contribution. The market was in a down period, so instead of losing money, I actually made more money because I had to pay back the interest, and bought more shares because the market had gone down. I was in a better place at the end of the loan than if I had not done it.