Comments on: Saving For A House: 401(k) vs. High Yield Savings

By: Free Money Finance

Free Money Finance — Fri, 16 Nov 2007 11:19:46 +0000

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By: jim

jim — Wed, 14 Nov 2007 19:07:35 +0000

Anne, John: That is a good point about comparing two things of differing risk and one that I never brought up when it came to discussing this with my friends. I thought the 10% penalty would be enough of a deal breaker (it still is, it’s just not a deal breaker if everything goes swimmingly over the course of two years+2 months).

By: John

John — Wed, 14 Nov 2007 17:12:43 +0000

at a base line, for your friends who are clearly not as proficient as you, you should probably be comparing similar investments. If you use 11% in the 401k, then use 11% for a taxable investment account, or vice versa. I agree with everyone else, that using 4% in one and 11% in the other doesn’t make any sense.

By: Anne

Anne — Wed, 14 Nov 2007 17:10:40 +0000

I still think you are conflating two concepts and by doing that, you are actually making the 401(k) approach look more attractive than it really is.

There are two issues. The first issue is, how much risk is acceptable for short-term savings? Most people agree that short-term savings should be invested with little risk.

The second, and totally independent, issue is whether it makes sense to put pretax money in a 401(k) knowing that you are going to need it in the short term and will incur penalties for early withdrawal. I think, if you run the numbers, it would be a long time before the small additional compounding due to the pretax growth would make up for the 10% hit.

So IMO, the first thing to do is to bust the myth that there’s any advantage to the 401(k) route vs. investing in stocks outside of a 401(k). And then the second step is to explain why investing in a risky portfolio is not a good idea for the short term.

By: jim

jim — Wed, 14 Nov 2007 16:42:25 +0000

I agree with risky business too, I merely wanted to show the math for those who were thinking about it. I outlined the assumptions too, that 11% return from the market would be up against a 4.75% high yield account, I think 11% return from the market each year over a two or three year span is unreasonable and risky business pulled out the historical data to prove it.

I wrote the post because I have friends who are considering this and even though I’ve tried to dissuade them from doing this for the retirement reasons, showing the ideal conditions having a horizon of 2 years is enough to dissuade most that this is a bad idea.

By: Anne

Anne — Wed, 14 Nov 2007 15:29:23 +0000

I agree with risky business. You are comparing apples to oranges. You shouldn’t compare a deposit account to a 401(k) invested in stocks–you should compare a stock portfolio held outside of a retirement account to one held within a retirement account.

By: risky business

risky business — Wed, 14 Nov 2007 15:24:12 +0000

You’re not accounting for risk at all here. Sure, in an ideal scenario the 401k might come out ahead, but over a short-term time frame like 2-3 years the returns are volatile.

For example, the S&P 500 from 2002 to 2004 returned around -6%. Sure, you could get lucky like from 2005 to 2007 where it returned almost ~17%, but is that a risk you’re willing to take? Taking the average in this case isn’t realistic because you’re not using a long enough time span.

The reason 401ks work for retirement is because of the long time horizon. Trying to leverage that for a short-term gain is akin to trying to time the market. My money would go into either a High Yield savings, or a CD. Given that you’d have a time frame in mind for when you wanted the funds available, I’d most likely opt for the CD.