Thursday, March 19, 2009

Why You Should Keep Contributing to Your 401(k)

In the current Wall Street bear market, you could buy hundreds of shares of stock for a fraction of what they cost a year ago. Many companies are trading at or below $10 per share. It’s a wonderful opportunity to get a lot of stock for not very much money. And if you were buying stock through your 401(k) through the bull market, that means dollar cost averaging will pull down the final cost of, say, 100 shares bought over the last two years. For example, if you bought 50 Citicorp shares at $67 last year, you paid $3,350. A few days ago, those same 50 shares would have cost you $116.50. (Of course buying them at all now is a risk, but the US government is not going to allow Citicorp to fail. Not now that we have given Citicorp so much money.) Your dollar cost average for those 100 shares would be $34.67.

But why throw good money after bad into the stock market? There are a couple of excellent reasons. One is that many, many solid companies are currently very underpriced. Thus the value of your purchase today is bound to go up as the economy improves. These companies have nothing to do with overleveraging or insurance credit swaps or derivatives, or the subprime mortgage market, for that matter. People still buy soup and soap, and many other items represented in the market. (Am I recommending that you buy Citicorp? It’s only a fun example, not a serious investment for us small-time investors.)

The second reason is that money you put in your 401(k) is shielded from taxes until you take it out. Yes, you could lose that money by investing it, but you could win big with your investments over time. If you don’t invest that portion of your wages into a tax-deferred account such as a 401(k) or IRA, you must pay income taxes on it right now. And you will have lost a portion of that money forever. Maybe as much as a third to a half. Investing is a gamble. Income taxes are not.

Strange, that the amount you could lose to taxes is the same as what most people have lost from their 401(k) in this down market: a third to a half. If you put that money into the stock market, you could lose it, but you might double it. If you let that money go to taxes, it is gone. I suspect that most people who don’t contribute to 401(k)s don’t realize that they’re taking a hit equivalent to the Worst Bear Market Ever—every paycheck.

Reason number three is that some relatively high earners will fall victim to the Alternative Minimum Tax if they don’t contribute to a 401(k), which is an even higher tax bracket and thus a bigger bite out of hard-earned income. Why let that happen?

Am I bullish on the stock market? I never have been. It’s a gossip mart, fueled by unrealistic expectations and skittish behavior. We’re seeing that in action very vividly these days. But I do have confidence that America’s actively traded companies, most of them, are in good shape despite their current stock prices. The soup and soap theme, if you will.

So think seriously about continuing your 401(k) contributions. Direct them to conservative investments if you prefer and your plan allows. But don’t waste the opportunity to keep and grow your money.

1 comment:

Anonymous said...

Another reason you should continue contributing to your 401(k) is the company match. Where else do you get, if you're lucky, a 100% gain on your money.

Yes, I've lost about half in my account. But, I just say to myself that that was my company's money and not mine.