The following is a guest post by fellow personal finance blogger William Cowie from the site Bite the Bullet Investing. In the post Reader Debate – Would You Borrow Money to Invest in Stocks?, William commented with a great story about his experiences with borrowing against 401k funds to purchase stocks at what he believed was a critical opportunity.
He has graciously volunteered to expand upon that story in this post. If you are interested in being a guest contributor for My Money Design, please feel free to contact me.
Do you hate debt? I do, quite passionately. Few things suck the joy out of life more successfully than debt.
I didn’t always feel this way. Business schools do a great job extolling the virtues of using Other People’s Money. Even the great Warren Buffett has literally billions of dollars in outstanding bonds (which are nothing but the pig of debt with designer lipstick).
But debt kills.
How do I know?
It Happened To Me:
In the early nineties I had a good job, making good money. Real estate was booming, but we didn’t have enough saved for the down payment on a house. So an (ex-)friend talked us into something called equity sharing, where someone puts up the down payment, and we get the mortgage. Then, when we sell the house, we split the profit 50/50. (Of course there was going to be a profit when it came time to sell the house. After all, this was Southern California.)
California experienced a fairly sharp recession in the mid-nineties with the derailing of the Star Wars military spending gravy train (which had boosted California’s economy unnaturally). I lost my lovely job, and discovered that finding a replacement was not as automatic I expected.
What happens in a recession? You lose your job and your house, you get wiped out, and you start all over again. At least, that’s what happened to me. Why? Arrogance is probably the most honest answer: “I know it happens, but it won’t happen to me. I won’t lose my job, I’m me, I’m invincible.”
We lost our house to a short sale. But I remember The Deal. The person who bought our house got just a killer deal on it, just because he had cash. He paid almost $70,000 below what we paid, and we didn’t even buy at the top of the market.
I wanted to cry and beat my head against the wall, because I should have known better. It felt so unfair. I should have been in that position. If I had just been a few years more patient, I could have gotten that house for that price. (Just imagine where we’d be today.)
Instead, I was impatient and debt, as we know, is the fuel of impatience. So we had to start all over again.
And that’s when I vowed: The next time this happens, I’m gonna be on the other side of The Deal. Recession is the only time The Deal comes along, and I vowed to be ready next time, even if it meant beans and rice while we waited.
It’s funny: when you encounter failure on that scale, you learn things about yourself you never knew. I never used to think of myself as a contrarian or a particularly determined sort of chap. But after this experience there was a steely determination I never felt before.
And my awesome wife, bless her, was totally on board. We started saving with a ferocity and urgency we never had before. We needed that ferocity, because here’s the thing with saving: In the beginning it looks so small, and small is so discouraging. You sacrifice and sacrifice, and after several months you take a peek at the savings account. And all you see is a few shriveled up pesos. A famous author once said it’s useless to pee against the Nile… and that’s exactly what it felt like in the beginning.
But the determination to get on the right side of The Deal kept us going. Along the way we bought a business with hopes of reselling at a small profit before the next recession, and kept maxing out our 401(k) contributions.
Nobody needs to be told we just came through the biggest dip in the economy since the Great Depression. The business thing didn’t work out, so that part of our plan went kaputsky. It was a hard experience, no question about it.
But it wasn’t the only thing that happened. In the heady days running up to the big crash, we started shifting some of our 401(k) money into money market accounts, just as a defensive measure. When the market crashed in September of 2008, we scrambled as fast as we could to move the rest, but of course we took some losses in that process. As the carnage in the stock market ran its course, we emerged with our 401(k) plans bloodied, but unbowed, to quote the famous Invictus poem.
As the stock market plunged, Warren Buffett’s credo rang in my ears: “When others get scared, I get greedy.”
As 2008 ended, I got greedy. I started looking for good companies in the stock market with little debt, whose stock got hammered in the crash. I used various stock screeners to find stocks more than 50% below their 52-week high, and with enough cash and low debt to ride out the slump without having to issue discounted stock just to keep managements’ jobs.
With hundreds of stocks to choose from, it was like shooting fish in a barrel. But, with our business wiped out, we didn’t have any loose change to go on the shopping spree which I had planned.
Borrowing Against 401k Funds:
I feel like someone at an Alcoholics Anonymous meeting confessing that. But I did it. Mutual fund managers simply can’t benefit from a dip like an individual investor. And so I did the unthinkable: I borrowed every dime that I could from our 401(k) plans, and bought.
I wasn’t interested in timing the market. All I knew was that in three to five years, those stocks were going to be well above what they were at the time we bought them. Even if they dropped after we bought them, the 3-5 year window would take care of that.
With wrapping up the failed business, the 401(k) plans had to go and they, net of the loans, were rolled over into our IRAs. When the dust settled after all was said and done and repaid, the value of our investments had more than quadrupled over a period of just over two years. Without the loans, we would have foregone about two-thirds of those gains.
Was I tempted to borrow again and repeat the exercise? You bet. However, I was mindful of the truism: Bulls and bears make money, but pigs get slaughtered.
So I didn’t. I’m glad now, because the juicy part of the stock market recovery is over, despite the publicity it’s getting now.
Every rule has an exception, which is a bit like saying when you point a gun to your face, it doesn’t always kill you.
I got killed earlier. But I was fortunate to be able to use debt to claw back some of that loss more than a decade later. So, I guess the score is 1-1, and it seemed like a good time to quit.
Editor’s Note: Thanks William for this personal story of triumph. Not only is this a positive example of borrowing against 401k funds to take advantage of a better opportunity, but it also demonstrates the importance of financial education and necessity of careful planning. Readers – Have you ever believed in an investment opportunity so much that you borrowed money or abandoned your prior savings goals? What extent would you go to make a financial comeback?
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