If you could lock in your gasoline price today with the guarantee that it will never go up, wouldn’t you do so?  Of course you would.  I wish I knew how, but I don’t.  However, I do know a way that you can lock in your income tax rates today so that you don’t have to worry about them escalating out of control when you need your retirement money.  It is called the Roth IRA.

Let me explain. With the traditional IRA, you get to deduct the contribution for the tax year it was made, but you will pay taxes when you start drawing the money out for retirement. The Roth IRA, on the other hand, is purchased after you have paid your taxes and is therefore tax free when withdrawn. When deciding which one is best for you, conventional wisdom is that if you believe you will be in a lower tax bracket when you retire, you are better off with the traditional IRA. Why? Because you were able to claim a tax deduction at a higher percentage, but pay those taxes later at a lower percentage.  A lower tax rate is normally assumed if your retirement income will be less than your working income.

But I ask: do you seriously believe that the tax structure when you retire will be essentially the same as it is today? Is it possible that even if your retirement income is less than your working income, your tax rate could be higher than today’s rates?

Why The Roth IRA is a Good Choice

Our current national debt is approaching $16 trillion and climbing by the second … nearly $50,000 per citizen.  As I see it, Congress has four possible choices of dealing with this debt:

•  We could spend less than we make. A great choice, but nowhere on the radar.

• We could print more money, but doing so will raise inflation rates, maybe to hyperinflation. Not a good choice.

• We could sell more Treasury Bonds, but our national debt is making these bonds more and more risky. Besides, neither families or nations can borrow their way out of debt.

• We can raise taxes.  Again, not a good choice, but, in my mind, the most likely one.

Our future tax structure is very uncertain because of our national crash course with debt. Are higher income taxes a certainty? No — but, in my thinking, they are a very high probability. If your retirement income is going to be about the same as your working income, or even a bit less, my recommendation is to lock in that tax rate now with a Roth IRA.  You will never, ever again need to concern yourself about future tax hikes.

That sounds like a great plan to me.

Related posts:

1. Rising National Debt Makes Roth IRA a Good Choice
2. Traditional IRA or Roth IRA: Which is Best For You?
3. Should You Roll Your 401(k) to an IRA? It’s Not A No-Brainer.

It’s hard to imagine that the financial crisis happened over three years ago.  The ups and downs of the market over these past few years have been anything but stable.  Just three years ago, you were probably looking at your retirement funds wondering where half of it went.  Trust me, I know how discouraging it was to see a big negative 40% in my retirement account, but I kept investing and I’m sure glad I did.

These last few years were actually a great opportunity for younger investors like myself to buy up shares at bargain prices.  While it’s impossible to say with any certainty that the market won’t repeat itself, I’m confident that my long term strategy of buying in at all prices consistently each month, (dollar cost averaging) should build up a solid balance for my retirement years.

So the question still stands – how should you invest in 2012?  For me the answer is simple.  My investing strategy won’t change one bit.  But it doesn’t mean that I’ll be ignoring the market altogether.  It’s important to have an understanding of how the stock market works and how your funds are performing, so I try to stay informed on those issues.  But the key is to not let the short-term news affect your long-term goals and investing strategy.

My 2012 Investing Strategy

• Increase my retirement savings at work.

The majority of my retirement savings exists because of the small contributions I’ve made to my retirement account at work.  I can remember starting out with $40 a paycheck and wondering if it would ever get past $1,000.  If I had kept my contributions at $40, it would have taken a while, which is why I’m glad that I increased my contributions annually.  Each year, I increased my savings by $40 or $50 a paycheck, which didn’t hurt my paycheck all that much.  If you’re fortunate to get a raise every few years, you’ll be doing yourself a huge favor by shifting some of it into your retirement plan.

• Invest after-tax dollars automatically.

I love to talk about saving for retirement and the tax advantages of Roth IRAs and 401(k)s, but I’d be missing a crucial part of my investing strategy.  Investing after-tax savings in a brokerage account is my second investing strategy for 2012.  It almost acts as an emergency fund that works much harder than a typical CD or savings account.

I invest my after-tax savings in index funds through Betterment.  (Read my Betterment review here)  If you’re not familiar with index funds, think of it as a family of well-diversified stocks (like a mutual fund) that performs on par with the market.

I know what you’re probably thinking: Don’t I want to beat the market?  Why shoot for returns that are on par with the market.  I hear what you’re saying, but I’m a believer that the average investor will have a very difficult time beating out the market in the long run.  Index funds have historically performed better than actively managed funds (see this article from the Motley Fool) so it’s not worth the effort for me to try and beat the market.

• Set aside ‘play’ money to invest.

I know I just said that I’m a long-term, index fund believing investor, but remember how I said that I didn’t want to ignore the market completely in 2012?  That’s because I enjoy following a few companies and investing in their individual stocks.  For that I use a brokerage account (like Scottrade or eTrade) and only fill it with what I’m comfortable risking.  Understand, I’m not investing in extremely risky startups.  I use this ‘play’ money to satisfy my interest in following a few companies closely.  Besides, it keeps me from wanting to make unwise shifts in my main retirement and investment accounts, so I don’t see any harm in it.

Do you have any investment strategies that you’ll be following in 2012?

Tim is a personal finance writer at Faith and Finance a Christian financial help blog that provides financial insights for individuals, businesses, and churches. Outside of finance, Tim enjoys spending time with his wife, playing the saxophone, reading economics books, and a good game of RISK or Catan. Find him on Twitter and Facebook and subscribe to the Faith and Finance RSS feed.

Related posts:

1. Should a College Student Invest for Retirement?
2. Dave Ramsey’s Baby Step 4: Invest 15% for Retirement
3. What Are Junk Bonds and Should You Invest in Them?

Today I am proud to introduce my newest staff writer: Alex Humphrey.  I am confident that you will enjoy Alex’s crisp and sometimes edgy writing style.  You can read more of Alex over at his site: Entreprelife.

You’ve heard the story about the Tortoise and the Hare, right? For those that weren’t exposed to the childhood favorite, it goes like this:

Tortoise is sick of Hare teasing him for being so slow. One day he challenges Hare to a race. As the race begins, Hare easily rushes ahead. When Hare is half way, he looks back and sees Tortoise far behind. To make tortoise look even worse, Hare decides to take a nap right on the track! But when Hare wakes up, he sees Tortoise inches from the finish line! He runs as fast as he can but is beaten by the tortoise who gleefully says,

“Slowly does it every time!”

The moral is simple: do the work and you’ll win the race. Hare thinks he can get by without effort and he loses. The tortoise slowly plods along, even when he’s far behind, and eventually wins the race.

If Tortoise was an investor (and I’m sure he is) he would become a millionaire the same way he won the race: slowly every time.

Invest Like the Tortoise

Imagine the Tortoise as a “normal” investor. He puts about 15% of his income into mutual funds with a pretty boring breakdown:

• 25% in Growth
• 25% in Growth and Income
• 25% in Aggressive Growth
• 25% in International

It’s average, boring and gets a normal 12-to-18% return. Some months are up, some months are down, but the tortoise plugs along for 30 years. If his investments were in a Roth IRA and he contributed $414 a year at a 12% interest rate he would have 1.46 million in 30 years. Even more exciting, our tortoise only contributed $149,000 dollars!

He’s a millionaire by year 27 and if he increases his contributions at any time he’s a millionaire significantly sooner.

What About the Hare?

The Hare doesn’t want to wait 30 years to grow that nest into a million bucks. Watching 4,000 become 5,000 that first year isn’t exciting. He’s investing in junk bonds, gold, and learning to time the market. He thinks he can get 10 or 20 times his investment by taking the risks. It’s more fun than the tortoise’s method and he will be a millionaire in a few years!

Sadly for him, history shows us that Hare investors get about the same returns as gamblers. They may see significant early gains, but in the end the house wins and they lose everything.

Be the Tortoise

It’s easy to get swept up in big numbers and “secret methods”. The Ponzi scheme works because the Hare’s method is more exciting than the tortoise’s.

But if you want to retire a millionaire, then you need to remember: “Slowly does it every time!”

And if you have more questions about investments, Joe has a several investing resources here on the blog.

Are you investing?

Alex Humphrey is a personal finance writer and coach at EntrepreLife a personal finance blog that teaches easy ways to dominate money by dropping debt, investing well, and saving for the things you love to do. When he’s not blogging he leads a youth group, spends time with his wife, and figures out new ways to teach people personal finances. You can follow him on Twitter and Facebook and subscribe to the EntrepreLife mailing list.

Related posts:

1. Are You Acting Like A Millionaire?
2. How to Ensure That You Will Never Be a Millionaire: Eight Great Tips

Junk bond does not mean junk

The phrase ‘junk bond’ has been tossed around quite a bit during this financial downturn and it’s worth investigating exactly what  people mean by the term.  If you were thinking that a junk bond was a sleazy investment like a ponzi scheme, you should keep reading, because that’s not the definition of a junk bond.  In fact, you might be invested in some without even knowing it!

First, a Look at Credit Agencies

We need to talk about credit agencies because bonds are deemed as ‘junk’ by their ratings.  In the US, there are five major rating agencies: Standard and Poor’s, Moody’s  Fitch, Dominion Bond Rating, and A.M. Best.   The most popular rating scale used by agencies is the following: AAA, AA, A, BBB, BB, B, CCC, CC, C, and D (bonds in arrears, or missing payments).  The AAA companies hold the least amount of risk and are considered to be ‘investment grade’ bonds, along with AA, A BBB.  Anything below BB is considered a ‘junk bond.’

*It’s worthwhile to point out that many people have looked down on these credit rating agencies because of inconsistencies in reporting and poor practices.  While we could discuss that issue for a while, it won’t change how bonds are rated.

Junk Bonds and High Returns

Junk bonds pay a higher return because they come with more risk.  The borrower (the company issuing the bond) needs money from you (the bondholder) but its credit rating is less than superb.  Think about your personal finances here.  We all get a credit score.  If your credit score is good, you get low rates on your auto and home loans.  If it’s poor (like companies who issue junk bonds) you’ll end up paying higher rates to borrow money.  Historically, the returns on junk bonds have averaged between 4-6%.

Should You Invest in Junk Bonds?

Now that we’ve discovered that junk bonds aren’t a scheme, it’s important to say that you shouldn’t go off to your brokerage and buy up all the junk bonds you can find.  First off, it takes a lot of research to find a company issuing high paying bonds that are in line with your risk tolerance and investment objectives.  Secondly, you might lose a lot of money if you don’t know what you’re doing.  Like any investment, you need to carefully look at the risks and consult a professional adviser.

But if you’re dead set on investing in a junk bond, search for a low fee, high yield bond fund that will spread your exposure to multiple bond funds.  Like equities, you don’t want all your eggs in one basket with bonds either.

Hopefully this helps to dispel any confusion you had about junk bonds and their integrity.  There’s a time and a place for junk bonds and they can be a valuable investment as long as you maintain a balanced portfolio.

Did you know much about junk bonds before you read this article?  If so, what else would you share about junk bonds?

Tim is a personal finance writer at Faith and Finance a Christian financial help blog that provides financial insights for individuals, businesses, and churches. Outside of finance, Tim enjoys spending time with his wife, playing the saxophone, reading economics books, and a good game of RISK or Catan. Find him on Twitter and Facebook and subscribe to the Faith and Finance RSS feed.

Related posts:

1. How Should You Invest in 2012?
2. My Car Needs an Engine. Should I Sell it, Fix it or Junk it?
3. Dave Ramsey’s Baby Step 4: Invest 15% for Retirement

Always know your risk tolerance

Arthur Cashin, Director of floor operations at UBS financial services recently said that in his decades of being a professional investor, he has never seen a more challenging investment environment.  If a professional investor fears the market to this extent, what should a part time, non-professional trader do with their money in the current market?

It might be more about what you shouldn’t do. Those with less experience often make mistakes which lead to catastrophic losses in their portfolios.   Even in the best of environments, nearly 80% of part time investors lose money. With that sobering fact in mind, an increased caution of risk taking is a healthy thing.  What should you do in an environment such as this and how can you protect your money?

Don’t chase return.

When the investment markets enter a period of little or even negative growth, inexperienced investors try to chase return. They look for products that carry a higher rate of return but they forget that along with that higher return carries a higher degree of risk.  Stay within your risk tolerance and understand that sometimes you aren’t going to see much of a return.

Don’t do just to do.

Ever felt like if you’re not putting money to work in some way, you’re not a good investor? A seasoned investor knows that sitting on the sidelines and waiting for the waters to calm is sometimes the best way to make money. If the market is down 5% and you’re down 0%, you’re beating the market!

If you don’t understand it, don’t touch it.

Do you know what a bond fund is? How about a leveraged ETF or a floating rate loan fund? If you don’t know what they do or how they work, read up and learn.   It is YOUR responsibility to understand your investments, so, even if your financial adviser is hyperventilating about how a certain product is perfect for you, keep saying “no” until you understand and agree with his recommendations.

Bottom Line
In football, there are times for offense and times for defense. When the defense is on the field, the team counts any points scored as “bonus” points.  In challenging investing environments, you’re a defensive player. Big gains are a bonus. Wait for the next bull market to get back on the offense.

Readers:  any other tips on how to invest during challenging economic times?

Related posts:

1. What is the Difference Between Saving and Investing?
2. 3 Things to Consider Before Investing in Gold

It’s hard to believe how much growth we’ve seen with gold in this past decade.  In the last five years alone, the price of gold has shot up nearly 200%!  As the US continues to work through its overwhelming amount of debt and as the stock market continues to move like a roller coaster, I’m sure we’ll see even more investors flock to precious metals like gold.  The more you hear about the uncertainty of financial systems across the globe, the easier it is to let the fear drive you to make decisions that may not be in your best interest as an investor.

Before you invest in gold, I hope you’ll consider these thoughts to help ground your decision to change your investment strategy.  As for answering the question, is gold a good investment, we won’t be covering it here, but you can hear my thoughts by following that link.

I’ll also make it a point to say that I am not guiding you into a direction to invest or not invest in gold.  No one knows with absolute certainty how gold will perform in the future, but that doesn’t change the fact that you should carefully research and approach that decision with caution.

1.  Is Fear Driving My Decision?

Yes, I know your 401(k) finally reached its pre 2008 level this year. The national debt level boggles my mind too.  Social Security… I don’t have any idea what it will look like in 20 years.  Should I go on?

There are plenty of things to worry us if we look for it.  Does that mean we should be oblivious about what’s happening with our economy both here and around the world?  Absolutely not.  I think it’s our responsibility to personally research and learn about how our economy works.  The same is true about our investments.  You wouldn’t jump into a stock that you haven’t researched, would you?

One of the biggest drivers of the rush to invest in gold has been fear.  I agree, there’s a lot of uncertainty out there that can cause you to be scared, but making an investment decision because you fear the unknown is scary in itself!

We don’t need to make decisions based on fear – 2 Timothy 1:7 says “For God hath not given us the spirit of fear; but of power, and of love, and of a sound mind.”  Having a sound mind is critical when it comes to choosing your investments, so ditch the fear and make an educated decision based on research and advice from a trusted financial advisor.

2. Is the Pursuit of Riches My Goal?

The rise in the price of gold looks awfully tempting, doesn’t it?  Sure, I wish I bought gold in 2005.  Even better, I wish I had bought Apple stock in 1997.  Or even better, I wish my parents had purchased stock in Berkshire Hathaway in the 70’s.  The returns of an investment look extremely obvious and enticing when you look at it with hindsight.

The investment phrase “past performance is not an indicator of future returns” should ring through every investor’s mind before they decide to invest.  Unfortunately, we can’t know how an investment will perform in the future, which is why chasing returns based on past performance is so dangerous.

I’m reminded of the verse found in Proverbs 13:11 that says “Wealth from get-rich-quick schemes quickly disappears; wealth from hard work grows.”  It doesn’t matter if it’s gold, silver, foreign stocks, or oil – if you’re looking to jump onboard blindly to ride the ‘high waves,’ you’re likely to get burned.

3. How Long Will I Hold Gold?

Here’s a great question to ask yourself before you invest in anything.  What’s your exit strategy?  Do you have a plan to sell when it reaches a certain amount?  What about a plan to sell as it comes down in price?  (Yes, even gold comes down in price depending on what people are willing to pay for it that day.)

If you don’t have a good idea as to how you can get out of the investment appropriately, you probably shouldn’t be in it.  Conservative holdings (5-15%) can make it easy to manage the sale of precious metals from your portfolio.  But if you’ve invested a significant part of your nest egg into gold, you may have a difficult time knowing when to sell.

Like it or not, emotions play a huge role when it comes to investments.  That’s why it’s important to approach any investment decision with rational thinking – not fear or greed.

What are your thoughts on investing in gold?  Is this a smart approach to take before buying gold?

Tim is a personal finance writer at Faith and Finance a Christian financial help blog that provides financial insights for individuals, businesses, and churches. Outside of finance, Tim enjoys spending time with his wife, playing the saxophone, reading economics books, and a good game of RISK or Catan. Find him on Twitter and Facebook and subscribe to the Faith and Finance RSS feed.

Related posts:

1. Gold and Silver Are Worthless
2. Three Actions NOT to Take in Difficult Investing Environments
3. What is the Difference Between Saving and Investing?

"Do not store up treasures in this world, where rust will destroy."

Tell me if you have heard this one, “Hey buddy. Have I got a deal for you! This is a zero risk high yield investment which will pay huge dividends. Guaranteed!” Sleazy and cheesy, huh? But don’t walk away just yet. There really IS such an investment …one that will pay dividends forever! In fact, forever is the key word. Once you start thinking in terms of eternity, you will be laying your money down. What am I talking about? An investment touted by no other than Jesus Christ: “Don’t store up treasures here on earth, where moths eat them and rust destroys them, and where thieves break in and steal. Store your treasures in heaven, where moths and rust cannot destroy, and thieves do not break in and steal. Wherever your treasure is, there the desires of your heart will also be.” Matthew 6:19-21

Absolutely guaranteed

There you go. Our investments here on earth will always be at risk. The stock market can fail, banks can fail, the dollar can fail and nations can fail. We foolishly think these investments give us security, but the truth is this: even if all our investments last us our entire lifetime, they will still be worth zero to us when our lives come to an end. A wise financial planner will challenge us to get out eyes off of today and think thirty years into the future. Jesus tells us to get our eyes off of this world and think thirty thousand or thirty million years into the future. According to Jesus, only an eternal investment is absolutely guaranteed to last. Everything else is guaranteed to fail. Does it not make sense, therefore, that we should be taking advantage of Jesus’ offer?

You can’t take it with you.

You may have heard this one, but it bears repeating. John D Rockefeller was one of the richest men who ever lived. After he died, someone asked his accountant, “How much money did Mr. Rockefeller leave?” His classic reply? “All of it.”

The Psalmist agrees, “So don’t be dismayed when the wicked grow rich and their homes become ever more splendid. For when they die, they take nothing with them. Their wealth will not follow them into the grave.” Psalms 49: 16-17

The bottom line is the obvious: investments in this life are temporary; investments in Heaven are eternal. We would do well, therefore, to make eternal investments.

How do we take advantage of this guaranteed investment?

In many ways, heaven is the antithesis of earth. God’s reign is unhindered in heaven while Satan is considered the “god of this world” (2 Cor 4:4). This life is full of sorrow, but all of our tears will be wiped away in heaven. We struggle with sin as long as we live on earth, but we will not even be tempted to sin in heaven. Our investments likewise are turned upside down in heaven: we build our earthly nest eggs by squeezing our possessions tightly, but we can only store treasures in heaven by giving away what we have.

This doesn’t mean that we should give away every penny we ever touch. God expects us, for example, to use money to provide for the material needs of our families (1 Timothy 5:8).  We should likewise be prudent in saving for emergencies and planning for our later years. But make no mistake: EVERYTHING we hang onto is fleeting. Eternal investments, on the other hand, can be made only by giving.

Think “delayed gratification”.

We live in a microwave society of instant gratification, but storing treasures in heaven is the ultimate form of delayed gratification. We are intentionally and deliberately giving away what we have here on earth, a tactic many would consider short sighted. However, think one moment of the ramifications of eternal investing. In his book “Managing God’s Money”, Randy Alcorn poses this scenario, “Suppose I offer you a choice of $1,000 today or $10 million dollars if you wait one year, then $10 million dollars more every year thereafter. Which would you choose?” Only a fool would accept the $1,000 today.

Yes, that year might seem like a long time, but the wait would be worth it. In the same way, heaven might seem like a long time off. But once you get there, won’t you be glad you were willing to forego the temporal treasures of earth in order to enjoy your heavenly investments forever?

Life here on earth is but a blink when compared to the eternity of heaven. The time to start your guaranteed investment is now.

Readers: Jump in here.  Does this seem like “pie in the sky” or something to be seriously considering?

Related posts:

1. Why Joe and Jan Do Not Have Long Term Care Insurance
2. How to Purchase Long Term Care Insurance: Ten Great Tips
3. How to Get Personal Finance Taught in a Public High School

I recently received a delightful letter from a college student who wanted my advice about investing for retirement. I say delightful because I simply don’t get many money management for college students requests, especially about retirement planning. 

In formulating my response, I made a couple of assumptions:

1. He either has debt (college or car) or needs his income to avoid such debt.
2. He does not have an emergency fund in place.

Read on for his letter and  my response.

Letter from Chris

Hi,

My name is Chris _____________. I am getting in touch because I have read a couple of your articles and I thought it would be a good idea to see if you would be able to offer me any financial advice. I am currently 21 and will be entering my fourth year in college. However I transferred into the program that I am in so I still have about two more years to complete. I have been talking with my mother about what I can be doing now to start saving money for retirement. I recently had the opportunity to invest in a 401k with my work, however it is only a part time job and I don’t know how much longer I will be here. I was also thinking about investing in an IRA. It is difficult because I don’t know what I want to do after I graduate or where I want to be geographically. If possible I would greatly appreciate it if you could give me any information or help. Thank You.

My Reply

Dear Chris,
I am very excited to hear from a college student who is thinking about how to invest for retirement. You are a rarity in today’s world! You may be surprised at my answer, but I would rather see you save your money right now instead of investing for retirement. The reason is simple: you will probably need the money, and if you have it tied up in retirement investments, you may be forced to borrow money for such things as:

· Making it through college.
· Buying or repairing a car.
· Paying for a place to live while you are looking for work after college.

Avoiding debt and paying cash as you go is a lifetime habit that will serve you well for years to come. It wouldn’t make sense today to be borrowing money while investing for retirement…sort of like taking out a loan so you can invest…not smart.

Once you finish college and get situated, I recommend paying off any outstanding debt and building up a good emergency fund before investing for retirement. You will be more relaxed, and, with no debt, you will have a lot more money to invest at that time.

Once you start investing for retirement, I like taking advantage of your 401k up to the point your employer matches. If he matches 3%, for example, I would invest 3% in order to get that “free money”. Investments above that 3% should be in Roth IRAs. You will have to pay your taxes on those investments now, but all growth in the Roth IRA is tax free. That is a good thing when you get ready to retire! Your goal should be to invest 15% of your income for retirement. If you do that, you will be fine.

If you want some good reading, you can go to my blog and read my posts on Dave Ramsey’s 7 Baby Steps. They will explain in more detail exactly when and why you do what you should with your finances. There are 7 articles in the series; the first is Dave Ramsey’s Baby Step 1: Baby Emergency Fund and there is a link at the end of each to the next in the series.

You may also want to read Dave Ramsey’s book, “The Total Money Makeover”. It is the best selling book on personal finance on the market, and a great read. In fact, I would be glad to give you a copy if you promise to read it. Just let me know.

Again, I am very impressed to hear from you. Please write back with any Roth IRA questions — or any other questions you have about my response…and about getting a free copy of The Total Money Makeover.

If you keep asking these great questions, you are going to do well in life.

Joe Plemon

Like I said, this was a delightful letter. It made my day and once again affirmed that at least some of our current generation is thinking about the future.   I wish I could be around when Chris is ready to retire…my guess is that he will be well prepared.

Readers: What did you think of my advice? What would you have said differently? How old were you when you first started thinking about your own retirement?

Related posts:

1. Dave Ramsey’s Baby Step 4: Invest 15% for Retirement
2. Retirement Funds Tanked? Time to Redefine Your Retirement.
3. How Should You Invest in 2012?

A reader recently wrote the following comment on my post 4 Reasons You Should Not Use Your 401k to Pay Off Your Credit Card so I have pasted both the comment and my answer, hoping that you readers will help scrutinize my logic and point out any flaws you may notice.  Obviously, I made some assumptions (which didn’t seem unrealistic), but I saw no other way to run these numbers without doing so.

Question from reader

Ok, so what if I don’t want to take out a loan on my 401K? I already practice the snowball effect and we give the minimum amount to our 401k – essentially whatever is being matched by our jobs. We have about $66,000 in revolving CC debt. We could use our 401K to eliminate that debt and be left essentially with only our mortgage payments and my school loan. With all this debt eliminated we could max out our 401k’s going forward at 15% each (we only give 5% now). It would also help come tax time as our taxable income would be lowered considerably if we give the 15%. We would also be able to give additional money to the IRA allowing our 401K to grow at a much more aggressive rate while being virtually debt free. I also realize if we take that much out we will likely be penalized at about $30,000 for this year. My question is, couldn’t this all be offset in some twisted way to work in our favor while getting virtually debt free? I don’t want to borrow, I just want to drain it and use it pay off the debt altogether. The CC debt was created due to losing my job and being out of work for an extended period. We are followers of Dave Ramsey and have been chopping away slowly but would love to start really charging after our retirement but at 5% per person it’s not really getting where we need it as quickly as we’d like. I just feel like if we can get rid of all our revolving debt we could begin really growing our 401K at break neck speed. Thoughts?
joeplemon May 4, 2011 at 10:36 am [edit]

My response

Let’s run some numbers based on the following assumptions:
1. You would need to withdraw $100,000 from your 401k to pay off the $66k in credit card debt.
2. You are 30 years from retirement.
3. Your combined annual income is $50,000, which means you are contributing $2500 annually (5%) to your 401k plans and receiving a 100% match for those contributions, effectively giving you $5000 annual contributions.
4. Over that 30 year period, your investments will earn an 8% average annual return.

Based on these assumptions,

If you continue what you are doing, your retirement nest egg will be about $1.7 million in 30 years. However, if you draw out the $100,000 and start anew with 15% investments (earning 100% match on your first 5% and zero match on the next 10% contribution), you would be effectively investing $10,000 annually. With an 8% return, your nest egg would be worth $1.2 million in 30 years, meaning that withdrawing $100K today is a $500,000 mistake.

It is actually more than that because you WILL eventually get that credit card debt paid off and bump up your investment contributions, thus increasing that $1.7 million you would have if you only contribute the 5% for the next 30 years. For example, if you paid off the credit card debt in five years and bumped your retirement investments to 15% at that time, (although I would recommend a big emergency fund before increasing your investments) your nest egg in 30 years would be about $2.1 million…$900,000 more than if you pulled the $100,000 from your 401k today.

I realize that the money in that 401k is tempting, but I urge you to leave it alone. One of you might consider a second job just long enough to pay off that credit card debt but even if you don’t get it paid down for a long time, your retirement will be more solvent by leaving your contributions in the fund instead of tapping what you have worked so hard to build up.

I also realize that I made some huge assumptions, but the results would be very similar even if the specifics changed considerably.

Please write back. Feel free to ask questions and let me know if what I have said makes sense.

OK readers — your turn. What advice would you offer? In what ways do you agree with me? How do you disagree?

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A recent article in Money magazine about purchasing a home through a short sale or foreclosure really piqued my interest.  With over one million unsold foreclosures and 550,000 probable short sales, the market is full of buying opportunities.  To add to those numbers, RealtyTrac predicted that another 1.4 million properties would be added to these lists in the next 12 months.

After I wiped the drool off my opportunistic little face, I was smacked with the reality that buying one of these homes isn’t just a cakewalk.   I did a bit of research and found a few things to consider before pursuing a foreclosure or short sale.  (I’d highly recommend doing extensive research about each sale process – these are simply things to consider right out of the gate.)

Considering a Short Sale?  Things to know:

Short sales can take anywhere from 2 to 6+ months to close.  Don’t expect to find a deal right away and sneak in with a short sale.

Make sure a short sale package has been completed and received by the lender. The short sale package generally includes these items from the seller:

• Purchase Contract
• Last 2 years of tax returns
• Last 2 months of bank statements
• Last 2 pay periods of pay stubs
• Preliminary HUD-1 / Settlement Sheet (breakdown of closing costs)

Not all agents are created alike.

Find a listing agent who has actually closed a few short sales in the last 12 months.  You don’t need someone new to the game when you’re trying to close a great deal.

Be ready to bid above the list price.

Those really cheap listings look attractive, huh?  In reality, bids generally end up pushing beyond the list price; that doesn’t mean you won’t get the house for a discount.  You just need to be aware of the market price for the area.

Considering a Foreclosure?  Things to Know:

Make sure the home can be financed.

You’ll probably have to prove that the home is in good enough condition to be financed.  It may be a great deal but if you can’t find anyone to finance it because it’s been trashed, you might be out of luck.

**If you’re serious about a foreclosure, it’s wise to have it fully inspected.  This might cost you $300 or more.  Check with www.ashi.org or nahi.org for a home inspector in your area.

Be leery of liens.

The last thing you want is to close the sale but have a lien tied to your new home because of unpaid taxes or other obligations.  You might want to involve a real estate attorney to make sure the property is free of legal surprises.

Find a bank that’s ready.

The bank servicing the mortgage may not actually own the loan.  If they do, it can make the process much quicker.  If not, you’ll have to involve another party and play the rules according to their terms, which may be even stricter and more burdensome.

Have you ever purchased a home through a short sale or foreclosure?  What was your experience like?  Did you get a great deal?

Tim is a personal finance writer at Faith and Finance a Christian financial help blog that provides financial insights for individuals, businesses, and churches. Outside of finance, Tim enjoys spending time with his wife, playing the saxophone, reading economics books, and a good game of RISK or Catan. Find him on Twitter and Facebook and subscribe to the Faith and Finance RSS feed.

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