Can We Talk About Leverage?

[Guest longinvestor]

An overlooked source of leverage for most individuals is a 401k loan.  The amount you can borrow is usually limited but you pay yourself back the interest.  Haven't done it myself, but I keep it in the back of my mind for the rare opportunity when (or if) I find an extremely high probably investment.

 

huh????

 

The purpose of leverage is to increase your balance sheet so you can make more income. But borrowing from your 401k is moving it from one place in your balance sheet to another?  And of course there is the double taxation issue.

 

 

 

The only advantage to borrowing from 401k is to invest in things you cannot invest in your 401k. But there is just such a high cost.

 

This is not accurate.  When you borrow from a 401k, you are not withdrawing money from your account.  The 401k plan is issuing you a loan and in-effect, your 401k holdings are the collateral. 

 

Also of note, some plans do not allow for loans.  It's up to the business owner when they establish the plan.

 

I need to make a correction here.  After reading more on this topic, a 401k loan does not provide financial leverage as I previously implied.  Randomep was correct in that it is in fact moving assets from one spot on the balance sheet to another.  However, a loan from a 401k plan does allow you tax free access to up to $50k of your 401k account balance.  The "interest" you pay on the loan is paid back to your own account.  Some have noted that you're repaying your loan with after-tax dollars.  This is true, but the loan is received free of taxes to begin with so its a wash.  The "interest" you pay yourself would be paid back with after-tax dollars however.  My apologies for the mistatement.  A 401k loan can be a cheap way to get cash, but it does not provide financial leverage as such.

 

Although I did not do this (wish I had), when your 401K is weighed down to mediocrity by the investment choices therein, taking out 50K and immediately investing outside would've worked out great. I know this is hindsight but how I know this would've been the case is that much of my net worth gains have come from rolling over my 401k's into IRA's, for me 401k and mediocrity go together. I have rolled over about 5 times in the past 15 years. Keep joking with my wife to quit or take a break from her job (get rehired back, they'd do so in heartbeat) so her 401K could have wings attached to it. Too bad the bastids cap off loans at 50K and make you pay it back in 60 months.

 

[fareastwarriors]

I took out a margin loan on my taxable account to help close a real estate transaction. I took out 40% of the maximum allowable amount.

[ERICOPOLY]

An overlooked source of leverage for most individuals is a 401k loan.  The amount you can borrow is usually limited but you pay yourself back the interest.  Haven't done it myself, but I keep it in the back of my mind for the rare opportunity when (or if) I find an extremely high probably investment.

 

huh????

 

The purpose of leverage is to increase your balance sheet so you can make more income. But borrowing from your 401k is moving it from one place in your balance sheet to another?  And of course there is the double taxation issue.

 

 

 

The only advantage to borrowing from 401k is to invest in things you cannot invest in your 401k. But there is just such a high cost.

 

This is not accurate.  When you borrow from a 401k, you are not withdrawing money from your account.  The 401k plan is issuing you a loan and in-effect, your 401k holdings are the collateral. 

 

Also of note, some plans do not allow for loans.  It's up to the business owner when they establish the plan.

 

I need to make a correction here.  After reading more on this topic, a 401k loan does not provide financial leverage as I previously implied.  Randomep was correct in that it is in fact moving assets from one spot on the balance sheet to another.  However, a loan from a 401k plan does allow you tax free access to up to $50k of your 401k account balance.  The "interest" you pay on the loan is paid back to your own account.  Some have noted that you're repaying your loan with after-tax dollars.  This is true, but the loan is received free of taxes to begin with so its a wash.  The "interest" you pay yourself would be paid back with after-tax dollars however.  My apologies for the mistatement.  A 401k loan can be a cheap way to get cash, but it does not provide financial leverage as such.

 

Although I did not do this (wish I had), when your 401K is weighed down to mediocrity by the investment choices therein, taking out 50K and immediately investing outside would've worked out great. I know this is hindsight but how I know this would've been the case is that much of my net worth gains have come from rolling over my 401k's into IRA's, for me 401k and mediocrity go together. I have rolled over about 5 times in the past 15 years. Keep joking with my wife to quit or take a break from her job (get rehired back, they'd do so in heartbeat) so her 401K could have wings attached to it. Too bad the bastids cap off loans at 50K and make you pay it back in 60 months.

 

It's a 2 month payback requirement if you lose your job.  It's only 60 months if you remain employed.  They will kick you when you are down if they have a legal right to do so.