In order to achieve success in any endeavor, whether it is mastering an instrument or managing money, certain philosophies or beliefs must be developed and turned into actions. Over the next two weeks, I will be sharing some of the philosophies that I have adopted, and that have served me well. The first two are noted below:
Do Not Loan Money
At first glance, that statement might strike you as miserly. Nothing could be further from the truth. I am not suggesting that you should never help friends and family in the form of monetary assistance. I am simply saying that you should consider it a gift vice a loan. A loan implies that the money should be repaid at some point in the future. There are two reasons why I believe this is a practice better avoided.
First, money has a tendency to put a strain on relationships, particularly if the recipient has a difficult time repaying the loan or is late with repayment. They are stressed because of their desire to repay the loan, and the lender is stressed because they had expectations of repayment, and likely, a plan for using the loaned funds for some other purpose.
Second, the practice can be disruptive to your retirement planning. Once you establish your retirement plan and have identified the amount you need to invest on a monthly basis to meet your goals, your first priority should be to pay yourself first.
If a situation arises and you have determined that a family or friend has a sincere need for financial assistance, and providing that assistance will not impact your plan, you should assist with a gift vice a loan. I assure you that if you loan a family member $300 of the $500 you were going to commit to your Roth IRA one particular month and they are not able to repay you, they are going to feel bad, you are going to feel resentment, and you will be $300 – not even counting the compound interest you will not have earned – further from your objective.
Conversely, if you find that you have an additional $150 at your disposal after meeting your monthly financial goals, and you can assist a family member with a gift of half the $300 they may need, they will be very appreciative, you will be glad you could assist, and there is no chance for resentment and strain on the relationship. Once you write that check for $150 it is forgotten forever and you move on and prepare to meet your next month’s goal.
Do Not Raid Retirement Accounts
Once the balances in your retirement accounts start to grow and you get well positioned on your rendezvous with retirement, there will probably be an occasion (e.g. helping a child with college tuition) when you will be tempted to borrow against your nest-egg. Generally speaking, you should not. Like the previous philosophy, I know this sounds a little miserly, particularly if we are talking about assisting a child with college costs. However, there are numerous reasons why you should not tap into your retirement accounts.
Consider the money in your 401(k). First, any money that you withdraw is no longer in its tax-protected status, doing what it does best, leveraging the power of compound interest. Second, over the long-term, you are significantly less likely to make more money by lending funds to yourself, or your child (e.g. for college), than you would have made had you left the money invested in your 401(k) account.
A third consideration, what happens if you borrow money from your 401(k) and then lose or quit your job? Answer, it is likely that you will be required to pay back the entire loan within a short time period. If you cannot pay back the loan within the given time period, you will be subjected to a 10% penalty on the balance of the funds if you are under 59½ years of age. Additionally, you will have to pay income taxes on the money because even though you might consider it a loan, the IRS will consider it an early withdrawal. If you, or a child, require a loan, you are better off seeking a more traditional loan vice dipping into your 401(k).
There you have it SavvyReaders, some of the philosophies that I have adopted over the years that have served me well. And yours? What belief or philosophy has served you well?