Investing Guide

I was thinking about the idea of borrowing a 401k to invest. It made me wonder. Not a lot of people write or talk about borrowing from a 401k to invest. At first, it seemed like a good idea because I am paying myself interest on the money I borrow. Plus, I will have more freedom with the money I borrow from the loan. So I would be able to add more money to my tax deferred account through the interest payments and I would use the funds I borrow to invest in any way I please.

My thinking was that in order to maximize my 401k, I could take out a loan and pay the interest payments which is pretty high. It is prime plus 1 percent, which is about 9 percent. The money I borrow from my 401k would be growing at a guaranteed 9%, but it would be with my money, so there is no actual increase in wealth. The purpose of the loan is to try to put as much money into the 401k as possible. Then I would try to earn money on the loan in a taxable account.

Obviously, this is for people who are maxing out all their tax-deferred accounts such as Roth IRA, IRA, and 401k. There are limitations on the loan, too. The maximum amount someone can borrow from their 401k is 50% or 50,000, whichever is less.
But then after thinking about it for awhile, the idea seemed bad.

Borrowing from your own 401k is a bad idea. The tax on the interest will be paid twice. This is because you will be paying the interest on the loan with after-taxed dollars and a second time when you withdraw your money. So investors are paying more money on the interest because it is used with after taxed dollars. For example,
Borrowing from a tax-sheltered account to invest in a taxable account does not sound very smart. Why would anyone want to lose the valuable tax-shelter vehicle? For young people, they should try to maximize their tax-deferred investments because they have a long time horizon to let that money compound tax free. Tax is a real big drag in a taxable account, which is why people try to put their most tax efficient assets such as stocks in there.

I am still thinking about this idea, though. Anyone have any thoughts about this subject?

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The Roth 401k was set to expire in 2010 unless congress renewed it. A lot of employers were reluctant to offer the Roth 401k because of its status. It costs a lot of money to set up the plan for their employees. They wanted to make sure that the Roth 401k here to stay before they offered the plan.

President Bush signed the 900 page pension protection act on August 17th, 2006. The act made the Roth 401k permanent now. Hopefully, this will spur more employers to offer the Roth 401k to their employees.

Roth 401k is like a 401k and Roth combined. After-tax money is invested into the Roth 401k instead of pre-tax dollars like a 401k. Employees can choose to invest in the Roth 401k (if provided), 401k, or both. The combined contribution maximum for both the Roth 401k and the 401k is 15,000.
Some of the benefits of the Roth 401k include:

1. No income restriction for contributing to the Roth 401k.
Roth IRA has an AGI limit of 95,000 for single and 150,000 for joint filers.

2. Higher maximum contribution.
Roth IRA’s maximum contribution per year is only 4,000. Roth 401k’s maximum is just like a regular 401k, which is 15,000 for the year of 2006.

Pension protection act will raise the maximum contribution for Roth IRA to 5,000 in 2008. Savers credit for lower income workers have also been made permanent. The new law makes it possible for employers to automatically enroll employees into a 401k plan.

I would like to invest in a Roth 401k, but my employer currently does not offer it. I feel it is more advantageous for low income, young people to invest in Roth IRA or Roth 401k because they will be taxed at a lower rate now and withdraw their money in the future at a higher tax rate.

I joined American Association of Individual Investor (AAII) for a year for $29.  I wanted to try it out to see if it was worth getting the lifetime membership.  So far, I like the website. 

I think the membership is perfect for people who are starting out.  There is a wealth of information for beginners who invest or want to learn how to invest.  The articles on AAII are well written and provide more depth and detail than most articles I read on other websites.  There seems to be more effort and thought put into writing the articles on AAII. 

I mainly joined for the stock screeners.  I wanted a better customized screener, but AAII does just has a basic one that is of no use to me.  There are many preset screens, many which have had good historical performance.  It was interesting to see that they had a Dreman and Graham screen, which was nice.  The screens are decent and a good source of stock ideas to do further research on. 

Their shadow stock portfolio is very interesting.  It contains micro cap stocks that have real money invested in it.  It has returned an average of 18.9% since inception 1993.

I would recommend joining AAII.  I will probably get the lifetime membership when my current one expires.