Should my recession dollars go into my 401k, or my wallet?

February 17, 2009 3:03 PM

Where is my money doing me, and the world, the most good right now: going into a 401(k), or going into my wallet and getting spent?

I'm in my mid-twenties, in a stable but low-paying job that I expect to be in for a while (he said, in a fashion that he hopes does not prove ironic). I am basically living paycheck to paycheck in NYC -- not starving, but not really saving in any meaningful way whatsoever beyond my company 401(k), which has quite a good matching program. For the last couple of years, I've been paying the maximum match into my account, and had built up a reasonable little stash (about a third of my annual salary) only to, of course, watch it take a 30%+ hit over the last few months. I only have a couple thousand dollars in credit card debt, which I would like to pay down/off, but the tight squeeze for what's left over from my paycheck doesn't really allow for that.

I was rebalancing my 401(k) into some less aggressive investments today -- I know that I am young, and there'll be plenty of time for a rebound, but there's no sense in wasting money when you know the market is probably still on its way down -- and began to wonder where my dollar is doing the most good for the economy: going into investments, or going into my wallet to be spent on consumer goods? And yes, that definitely is where it would go if I reduced the percentage of my paycheck that goes into my 401(k): food, home goods, etc.

Thoughts on this matter? I am obviously loath to give up much of the "free money" that comes from a company match, but I am also loath to watch every dollar I put into my 401(k) turn into sixty-five cents when it could turn into a dollar's worth of food, or furniture, or entertainment. And on the larger scale, do I help America more by buying a new couch instead of another share of a mutual fund? Should I reduce (not eliminate) my contribution to my 401(k)? Or stick to business as usual and try to make my budget work another way? I'd like to hear some thoughts that go beyond the conventional wisdom of "you should never ever stop paying into your 401(k)," unless you can make me see that argument in a whole other way.

posted by logovisual to work & money (15 comments total)

Do not give up the free money from your match. You have no idea what will happen in the future, it is a free 100% rate of return, and your consumer spending will have no impact on the economy.

Besides, buying a share of a mutual fund will help America, as funds with large redemptions will be forced to close and people connected with the industry but not at fault for the crisis will lose their jobs.
posted by selfnoise at 3:26 PM on February 17

Doing you the most good? In your 401(k). Conventional wisdom it may be, but you're near a record-low market and you have, what, forty years to recover at a historically-proven 8ish% annually.

Doing the world the most good? Well, that's a toughie. The US (and developed world generally) has long had piss-poor savings rates, but that's changing, largely because of a) deflation of inflated asset values, changing debt/savings ratios, and b) people retrenching consumer spending and use of credit. That helps them, but not the economy -- see John Maynard Keynes, the paradox of thrift. In a recession what's good for individuals -- saving and retrenching -- is disastrous for the economy as a whole.

So if you want to be socially responsible, at your expense, yes -- spend instead of saving. But try to invest it in things like durable goods so you're helping sustain jobs and allowing someone else to keep spending. Or use the money to start a business yourself. Buy government bonds. Lots of things in aggregate stimulate the economy, but you can't act in aggregate.
posted by dhartung at 3:26 PM on February 17

You don't know that the market is on its way down. Various models give various predictions for that. If you knew it were going down, then yes, of course stop putting money in.

But you don't know that. Of course you don't know it will go up, either. But either way your company's match is free money that you simply won't get. Every dollar you put into your 401(k) is actually immediately more than a dollar due to that match (dunno if the match is 100%, but keep it in mind when you think of how much a dollar you put in becomes).

If you were arguing that you want to stop putting money in to pay down your credit card debt, or in order to put a down payment on a home, then you might have an argument that it's better for your own finances. The benefit of being cash-rich right now isn't being able to buy yourself a new couch; it's being able to buy much larger purchases that you would normally need financing for.

I can't speak to whether your new couch or new mutual fund share helps the economy more, but keep in mind that buying that fund means stocks are being purchased; it's not like you're stuffing the cash in a hole somewhere and depriving the economy of its use.
posted by nat at 3:27 PM on February 17

If there's one thing this crash should be teaching us it's that there is no such thing as a guaranteed return. Period. Immediate consumption is the only way of avoiding all risk to your portfolio, though immediate consumption has the downside of not allowing you to save for a rainy day.

Honestly, I'm not at all convinced that 401(k) accounts, or at least the animating reason for their existence, i.e. tax breaks, will exist when you're 65. Four decades is a long time when we don't know what the financial landscape will look like four months from now.

But those concerns aside, the single best thing you can do with the money that's going into your 401(k) at this point is to pay down your credit card debt. Seriously. With matching funds from your employer, you're making an instant 100%, but with the market behaving the way it is, that could easily look like 10-15%, if that. Your credit cards on the other hand likely have double-digit APRs. There's no way you can earn that much with any investment vehicle compatible with your 401(k) in today's market, and even matching funds aren't a slam-dunk winner when your principle could well diminish.

Pay down your debt. More to the point, stop spending more than you earn. That's how we, collectively, have gotten ourselves into this mess.
posted by valkyryn at 3:28 PM on February 17

Ok, I apologize, I missed the bit about credit card debt. Pay that off then see above.
posted by selfnoise at 3:35 PM on February 17

You're not going to single-handedly spend the US out of a recession. Do what's smart for you. Leave the money in the market, and find a way to pay down your debt.
posted by chrisamiller at 4:05 PM on February 17

You don't know that the market is on its way down. Various models give various predictions for that. If you knew it were going down, then yes, of course stop putting money in.

If you knew it was going to go down enough to eat up all of your employer's match, then of course you would stop putting money in. But you don't know that, and the match is essentially free money. Leaving it on the table is like giving up a portion of your salary.
posted by mr_roboto at 4:12 PM on February 17

do I help America more by buying a new couch instead of another share of a mutual fund?

It doesn't matter to anyone besides you. As long as you don't stuff the dollars in a mattress, you're good.

Actually, even if you stuff the dollars in a mattress and burn the mattress, you're good on some level, since each dollar is a note that doesn't have to be redeemed. It's like you gave everyone a teeny, tiny interest-free loan.
posted by Cool Papa Bell at 4:20 PM on February 17

Depending on what kind of investments you're directing your 401K funds into, you really shouldn't look at it as a savings account where your money is disappearing when the market tanks. What you're doing, if your 401K is invested in stocks (which it should be under normal circumstances at your age) then what you're actually buying is a product, the share in the mutual fund or whatever. That product may gain or lose value according to the whims of the market, but you will still own that product. Assuming you're directing a set percentage of your salary from each paycheck into the 401K, you're actually buying more of that product when the market is low than you would otherwise, which gives you much more potential to gain when/if things turn around. Your view on things turning around will obviously depend on how optimistic you are.

So yeah, your dollar that you put in last month bought something that's worth $0.65 now, but this month you'll be able to buy almost two of the exact same item, so if it goes up to a dollar again you'll have made $0.70 right there. If you're really scraping by, maybe pulling back on the 401K contributions from your salary would be a good idea, if nothing else just to pay off your debt. Maybe reduce contributions for one quarter and then go back to full strength after that?
posted by LionIndex at 4:28 PM on February 17

I was in a very similar situation (still am, actually) and I opted to reduce my contribution (which, of course, reduces my match). I live paycheck-to-paycheck and needed the money now for my living expenses and to pay down debt.

My rationale was that I'm young, and can go back to a higher contribution rate when I am more financially secure and have more debt paid down. I felt that 1-2 years of investing a bit less in my early 20s was not going to ruin me financially for my 60s if I made sure to increase my investments as I got older.

However, I knew that I am leaving my current job to go back to school in the fall and will most likely lose my employer matching funds because I won't be fully vested. I got lucky, though, because I was lazy and forgot to call and change my 401k from the default money market to an aggressive portfolio when my company changed vendors last year, and actually still came out ahead at the end of 2008.
posted by fructose at 8:46 PM on February 17

1-2 years of not investing can literally cost you hundreds of thousands of dollars later.

Compound interest, man.
posted by empath at 9:56 PM on February 17

Also, remember that when you buy stocks (as the components of the mutual fund), you aren't just putting money into a savings account. You are buying tiny percentages of various companies. I say this for two reasons:

1- The nominal value of the account is sort of meaningless. The stocks aren't really worth anything until you sell them. Its like buying any other utilitarian device, like a car or a piece of jewelry. You bought it because you liked it, and it fulfills a need. My car could be worth $15 on the market, but I don't care because I'm not selling it. Or jewelry- you buy it (presumably) because you like how it looks. It doesn't look any worse because it goes down in value.

2- And many stocks (components of your mutual fund) pay dividends. The book value of the stock can dance around and seem to show a loss, but all that time you have been generating cash that your fund manager uses to buy more stocks (hopefully). Thus increasing your percentage ownership in those companies.

So, when it comes time to sell, even if the market value of the stocks hasn't performed exactly how you'd like, you still have done pretty well.

Also, to reinforce the idea that selling an otherwise good stock just because its market value has gone down is usually a bad idea. You paid what you paid because it seemed like a good value for what you were getting. If the underlying company hasn't changed and still has the same bright future you thought it had when you bought it, you should hang on. Unless you really need that money, or want to buy some other company that has even more upside.

The low prices that so many stocks are at right now makes it a great time to get in the market, provided you buy into a stock or a fund that has long term growth in mind. You are getting more bang for your buck. Further, my opinion is that the biggest recessionary influence right now is a lack of confidence. People aren't spending because they fear that they will lose their jobs soon, or because they hope prices will go down even further. Buying stocks, thus increasing the demand for stocks which increases the price, will have more influence than going out and buying junk you probably don't need. The analysts believe that the stock market is a leading indicator for confidence returning to the economy, and if they see the market fattening up, they might just shut up a little with the doom and gloom talk.
posted by gjc at 6:29 AM on February 18

Pay down/off your credit card debt. The sooner you get that paid off the more free money you will have every month and the less you will have to pay out in total. It is surprisingly easy to do this, you just need to be disciplined and make it a priority.

After doing that the best thing you could do for yourself & the economy is put your money in the bank. It is insured by the FDIC (up to $250k) and will help ease the bank's credit stress.

The other reason I suggest putting your money in the bank is that we're going through deflation right now and that will probably continue for some time. Your money will be getting more and more valuable for however long that is, even as you make money off the interest. Goods (incuding stock & real estate) will lose value through that whole time.

I'm not a fan of 401k investments. The matching program mitigates that slightly, but not enough for me to invest in one personally. You are extremely limited in what you can do with your own money. The conventional wisdom just traps people in the market.
posted by thekiltedwonder at 8:05 AM on February 18

I only have a couple thousand dollars in credit card debt, which I would like to pay down/off

Job one. Do it. Compound interest is working against you here. Esp. if deflation continues.
posted by IndigoJones at 8:42 AM on February 18

All of this advice to pay off the debt first is fine enough, but it's completely ignoring the matching funds. You would actually need to run the numbers to find out what it works out to for you, but let's say it's a 100% match. So you invest $x and get $2x deposited in your account. Even if this account loses 40% of its value, you have $1.2x in the account at the end of the year. That's still a 20% return, tax free. The credit cards may or may not be worth paying off first.
posted by mr_roboto at 2:56 PM on February 18