Question of the Day – 401(k) Loans

Here’s today’s question(s) of the day:

Do you think it is too easy for people to borrow from their 401(k) plans? Have you ever borrowed from your 401(k)?

My wife and I have borrowed against her 401(k) when we bought our house in 1999. This was back in the day when her 401(k) was our only source of meaningful savings. Although it worked out well for us, I can’t say that I would recommend it for everyone.

What about you?

Avoid Cashing Out Your 401(k)

Check out this quote from a recent Wall Street Journal article by Andrea Coombes:

…about 40% of workers in their 20s and 30s said they had cashed out their 401(k)s or 403(b)s when they switched jobs, according to an online survey of about 1,200 people conducted in January for Fidelity Investments by CMI, a research firm.

Quiz time:

You quit your job and take a new job with a different company. You have $800 in your old company’s 401(k) plan (you had just started contributing). Do you:

1. Move the money to your new company’s 401(k) plan?
2. Move it to an IRA?
3. Cash it out because it’s such a small amount of money?

Of course options 1 and 2 are the best. Number 3 is the worst. But, how bad is it?

Well, for starters, your employer will have to withhold 20% of your $800 for income taxes. You will also lose another 10% due to the IRS’s early withdrawal penalty. So, your $800 becomes $560 by the time you actually receive it.

Now, what’s the opportunity cost for cashing out your 401(k)? As you can see from the following graphic, it can be a significant amount over a long period of time:

Don’t underestimate the potential growth of a small amount of money! Instead of looking at $800 as a small amount of money now, consider it’s future value if invested properly. And, if there’s ever a time when you are tempted to cash out your 401(k) in order to pay bills, fix your car, or take a vacation, PLEASE re-read this post!

Don’t Run From the Bear

My friend, Allan Roth, wrote a great article about the bear market in the latest issue of Index Universe. I particularly like this quote from the article (emphasis mine):

At least I know that I don’t know what the market holds for us during the next six months. But, there are some things I know. First, I know that the market is a 17 percent better buy today than it was at its height during October 2007. A strong argument if ever I heard one that now is the time to start buying.

While this is a very logical argument, it falls on deaf ears when it comes to human behavior.

He then went on to illustrate his point with this interesting graphic showing equity mutual fund flows:

If there was ever proof that people do the opposite of what they should do, this is it. Instead of running from the bear [market], people should stare it down and call it’s bluff. Eventually things will turn around. Just rejoice at the marvelous big sale that’s going on right now in the market.

Bozo’s Question of the Day

Today’s Question of the Day comes to us from AFM reader, Bozo:

Given all the pros and cons as of late regarding the stock market, and the classic analysis of John Bogle (formerly of Vanguard) on index investing and “not trying to time the market”, it might be fun to ask:

“Have you tried to catch ups and downs in the stock market? Have you succeeded? If so, any suggestions?”

This might spark a bit of back-patting, for those that have done well. For me, well, I’m down for the year (about 2.5% overall), but only because my CDs are hammering away at 5.75%.

Exclude those who are overweight energy; yes, we know you are up. Your day will come. It all reverts to the mean. Trust me, I held energy stocks when you could not give away Exxon or the drillers as a “gift with purchase”.



PS: Hope you had a nice vacation.

The only “timing” I do is done when I rebalance my portfolio to get it back in line with its allocation. No, it’s not exciting, but I’m not a market timer.

What about you? Are you like me or do you try to time the market?

NOTE: Comments left with hyperlinks to some “trading system” or something silly like that will be deleted so please don’t waste your time.

2008 vs. History

I know you’re probably getting tired of looking at this stuff but I thought these two graphics I put together are interesting.

The first one is a bar chart comparison of this year’s monthly total returns for the S&P 500 Index vs. the long-term average for that month. As you can see, it hasn’t been a very good year so far. June really stunk it up.

The second graphic is the actual numbers from the first graphic but displayed in an easy-to-read format (for all you market junkies).

It’s tough to say what lies ahead for the rest of 2008. All I can say is the first half was a blood bath, especially for the financial sector.

It’s Official: June Stunk!

Take a look at this table I downloaded from Standard & Poor’s website:

June Stunk!

The financial services sector alone was down over 18% for just the month of June!

Of course the question on everybody’s mind is:

Is this a buying opportunity?

Well, I’m not one to time the market but a recent article ($) in the Wall Street Journal puts this market in perspective:

…the S&P 500 now trades at a price-earnings multiple of about 15 times this year’s expected earnings.

The 10-year average is 18.7, covering a period of investor exuberance, as well as the 2000-2002 market downturn. The 24-year average P/E ratio is 15, and that includes a period of much higher inflation than now. That all suggests that the market is reasonably priced, though not yet at bargain-basement levels.

Some investors like to compare the market’s earnings yield, or its earnings divided by price, with the yield on safe bonds, as a barometer of value. Today, the stock market’s earnings yield is about 3.36 percentage points above the yield on 10-year Treasury bonds, suggesting stocks are more attractive than bonds.

Of course the flaw with forward-looking P/E ratios is that future earnings are never reliable. So, the article mentions using a P/E based on the last 12 months of earnings. That P/E was around 21, compared to a long-term average of about 16. So, stocks don’t look exactly cheap if you use that measure.

Bottom line:

If you’re in this for the long-run, then I wouldn’t worry about it. Just keep socking money away each month and consider the downtimes as stock market “sales.” Think happy thoughts.

We’re Looking at the Second Worst June in S&P History

As of Friday’s close, the S&P 500 Index is down 8.55% on a total return basis for the month of June. If things don’t improve during Monday’s trading, this June’s performance will be the worst June performance in S&P 500 Index history and the second worst in the S&P Index’s history. Remember, the S&P Index didn’t become the S&P 500 Index until 1957. Prior to 1957 it was composed of 90 stocks. Anyway, here’s a ranking of the ten worst Junes in the history of the S&P Index:

Although this June isn’t nearly as dismal as 1930’s -16.15%, it is still pretty bad compared to the other worst returns for June. However, take heart. This June’s pitiful performance is the 38th worst monthly performance of all months going back to 1926. In other words, it could have been a lot worse!

Oh, and in case you’re interested, Standard & Poor’s has a pretty cool performance tool that you can use to lookup the historical returns for the index. You can access it here. All you have to do is fill in the date and the table furnish you with the return for the index up to that point. Just be sure to use the TR or total return numbers if you’re using the index as a benchmark. It’s pretty cool tool. I use it all the time.