There was a recent article on the CNN/Money website entitled Amateur investors tap 401(k)s to buy homes that discussed an increasing trend of 401(k) investors who tap their accounts to buy houses. The thought process is to take advantage of the hot housing market in some areas on the country with money that would otherwise be locked up in a 401(k) until retirement. Home prices are appreciating in some markets, so what’s wrong with this strategy?
Plenty is wrong with it, let’s take a look.
You distrust Wall Street but you trust the housing market? Really?
The article cites the distrust that some of these investors have of Wall Street and a desire to own hard assets. I get the distrust of Wall Street in the wake of the 2008-2009 market drop. These same folks must have short memories regarding the role that the drop in housing values played in the recession and the lingering effects of on many families. Yes prices are low, but they are rising. Are you knowledgeable enough to know if the property that you are buying is really a good deal? Distrust Wall Street all you want, but the fact of the matter is that investors who hold a reasonably diversified portfolio saw their 401(k) and other investments recover within a couple of years of the 2009 market bottom.
Are you getting in too late?
According to the article, Wall Street Investors are also entering this market and in some cases have bid up the price of homes in many of these hot markets. Much like the John Hancock TV commercial touting the idea of getting back into the stock market now that it is at new highs, is this an ideal time to be taking your retirement funds and investing them into a “hot” housing market?
Are you smarter than the professional investors?
As mentioned above this opportunity has come to the attention of Wall Street investors. Think what you want about Wall Street, these firms have the resources in terms of capital and research that you don’t. I’m not saying that individual investors can’t outdo the professionals, but ask yourself are you one of these real estate investors who can? Do you want to risk your retirement savings to find out?
Understand the potential costs and risks
In order to get at your money in a 401(k) plan you will likely need to take a loan from the plan. There are no tax consequences of doing this and as long as you repay the loan there won’t be any. Understand, however, that if you leave your job before fully repaying the loan, any remaining loan balance could end up becoming a distribution which would trigger income taxes and a 10% penalty if you are under 59 ½.
Further there is a potential opportunity cost. Are you convinced that your real estate investment will outperform what you might have gained in your 401(k) plan? Additionally, if your investment goes south you might end up with a property that is worth less than you paid for it, you are paying back your loan on the 401(k), and the house might be underwater if there is a mortgage involved.
Look before you leap
Let’s be clear, I’m not against investing in real estate, in fact many have made their fortunes from doing just that. What I am against is a novice who has read about the opportunities in the housing market taking funds from their 401(k) and investing in something they barely understand.
Will this always end badly? No. This might be a successful route to take for someone who understands real estate investing and who understands the risks. If this doesn’t describe you ask yourself is this a good use of my retirement funds?
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