Investing/Saving Advice Needed

ThrillaGorilla

So here's my situation: I am currently sitting on ~$11k in cash and I'm trying to decide what to do with it. When I purchased my house last August I took out a loan against my 401(k) ($8k) to put towards my down payment. That loan essentially takes $150 out of my paycheck each month and will continue to do so for another 53 months. The loan is at 5% interest, but all of that interest is just reinvested into my 401(k). I live below my means and have no other debt aside from that loan and my mortgage. I do also earmark a portion of this money for college funds for my nephew (nephews as of next Tuesday ), so realistically I have about $9.5k that I can play with. I have two options I am considering, but maybe you guys will have better ideas of what I can do with the money.

Option 1: Repay my 401(k) loan in full ($7.2k as of right now). This will free up some extra money each month that could be put back into savings/IRAs. Also, in the off-chance that I separate from my company I will be forced to pay the money back, in full, within 90 days anyways. Paying back this loan would ensure that what is in my bank account is actually what I would have in the case of job loss.

Option 2: Do nothing. Just hold on to the excess cash and keep it in case something big happens. This would mean something other than a job change, because then the loan would be forcibly paid back making all of this moot. Going bare bones with my expenses, this money could last me 6 months.

So H/A, what's your advice? What do I do with this money?

Djeet

Accelerate payoff of the 401K loan. Leave yourself as much of a cushion in your cash reserves as you need, but you want those funds back in your retirement investments.

I'm not sure how much you can save net of expenses, but you should probably have 6 months of burnthrough cash in savings anyways, net of obligations incurred should you change/lose employment.

Serpent

You'll get a guaranteed 5% return by paying of your 401(k) loan. That's pretty significant.

edit:
I misread. You won't get that return at all -- you get it regardless.

What kind of investments are in your 401(k)?

ThrillaGorilla

Djeet: It's an all or nothing type of payback. Would you still recommend this knowing that I will have to pay back the whole amount at once?

Serpent: If you need specifics I'll have get into my account to give you those, but I break down my investments like this: 25% Large Cap, 25% Mid Cap, 25% Small Cap, 15% Foreign, 10% Stable Funds. For reference I'm 27, so any suggestions at where I may be making investment mistakes is also welcomed.

Thanks for the advice so far.

RUNN1NGMAN

Financially speaking, earmarking money for your nephews is a horrible decision. There's lots of ways to get money for school: scholarships, grants, loans, etc. There's no such thing as a retirement scholarship or retirement loan. Most financial planners will tell you that saving for your kids' college tuition is pretty much the lowest priority as far as investing for the future.

Sunday_Assassin

I'd say pay off the debt. However manageable a debt might be, so long as you can foresee no significant expenditure in the not too distant future, it's always advantageous to be rid of it.

edit: If you're living below your means, and are already putting aside extra money, your cash reserves will replenish themselves soon enough. Pay off the debt and forget about it.

-Phil-

If you do not have an emergency fund setup I suggest you do so with part of the money. Since your only debt is the loan, depending on your situation (married, kids, etc.) I would try to create a 5 to 8 month e-fund with the money. Once that happens, accelerate payments to your loan and pay it off as quickly as possible.

Djeet

I'd do it in your situation simply to clear myself of financial obligations, but ... I feel very secure in my job and have no plans in the near future to change jobs, my wife also brings in an income, and we've no problem going into financial survival mode in case one of us loses employment. So when presented with your situation I can tolerate less savings if it takes a debt off of me, especially if the proceeds are funding my retirement.

IMO people tend to overly value liquidity and perceived flexibility, which can force an inflexible attitude towards decision-making.

If you pay it off you'll still have around $4K in the bank, to which you can add the $150/check that's going to servicing the 401K loan. If you are as thrifty as you say then it shouldn't take long to build up your savings again.

I am assuming that the loan funds from the 401K decremented your 401K funds available for investing by the loan amount. For example, say you had $20K in the 401K account before borrowing, and you've fully invested the $20K in various funds. You then borrow $8K to help with the downpayment, leaving only $12K in the 401K invested in funds. The problem here is you get a relatively cheap loan at the expense of having $8K less of investments. It seems likely your retirement account will not be optimally positioned to take advantage of any recovery over the next year or 2. Now if the loan operates differently (e.g. you still have the full $20K invested), then it just comes down to the tradeoff between incresed liquidity vs. lower debt load.

Do you foresee "something big" happening to you, or is this just concern for unplanned outsize expense (car repairs, medical bills, major home repair, etc.)?

Thanatos

You should have about 6 months of living expenses in savings in the current economic environment. Take that money, use the rest to pay down your 401(k).

Your 401(k) profile is maybe a little conservative for someone your age, but again, in this economic environment, no one's crystal ball is going to be absolute.

underdonk

Always pay your consumer debt back before you consider investing anything. I would pay back the loan you took out against your 401K and use the rest to start building an "emergency fund". After you have three to six months of expenses saved up in your emergency fund, consider investing what you are able to save after that.

Serpent

I think you should payback your loan to your 401(k) immediately, and use the rest to build up a external savings.

ThrillaGorilla

Thanks for the advice guys. I'm going to bite the bullet and pay back that 401(k) loan today. It's tough parting with that much money, but I think most of this advice is dead on. Thanks for helping everyone!

firewaterword

ThrillaGorilla wrote: »

Thanks for the advice guys. I'm going to bite the bullet and pay back that 401(k) loan today. It's tough parting with that much money, but I think most of this advice is dead on. Thanks for helping everyone!

I'd say that's the right call, and from what I understand, you'll still have some left over for re-investment. Do you currently have a Roth IRA? If not, that would be a great place to stash the remainder for some tax-deferred earnings.

Two questions out of curiosity, if you don't mind. First, what was the tax impact of taking the loan against your 401(K)? I know there are provisions that allow penalty-free withdrawals for first time home buyers, but haven't heard of a similar loan situation. Secondly, with regard to the interest, I am correct in reading that the 5% you "pay" goes back into your 401(k)? Thanks!