The worst advice EVER!!

In an article that appeared on Smartmoney.com (http://blogs.smartmoney.com/advice/2011/08/22/when-401k-loans-are-a-smart-move/) on August 23, 2011, Olivia Mitchell from the Wharton School of Business and David Wray of the Profit Sharing / 401(k) Council of America praise those who used 401(k) loans before the market crash of 2008 and the recent market downturn.  Their logic is that since those people sold their stocks while the market was higher and are now paying themselves back at an interest rate of about 4.25%, they get the best of both worlds – selling high and a getting good interest rate.  This rationale misses 2 major points:

1. In most 401(k) plans, you lose the ability to contribute to the plan while you have an outstanding loan.  Therefore, you lose your company match as well.  I would argue that if your company matches 100% on the first 3% of your contributions, you lost a guaranteed 100% return on that money.
2. If your goal was to protect yourself against losses in the 401(k) account, you would have been better served to move some of the money from stocks to a long term government bond fund.  The yields on many long term government bond funds are in the 3% to 4% range, plus you would have seen capital gains as the prices of these types of funds has increased as the stock market has struggled.  For example, the Vanguard Long Term Treasury fund has a 3.57% yield, and is up almost 20% this year because of the “flight to safety” as stocks have lost 15% of their value.

The article also avoids discussing the impacts of bankruptcy.  In bankruptcy, money in retirement accounts is generally protected from your creditors – in other words, they can’t get their hands on it.  If you borrow against a 401(k) to pay your bills but file for bankruptcy anyway, you take money was protected against your creditors and give it to them.

Finally, I disagree with the rationalization at the end of the article about this set of circumstances being unlikely to repeat again.  History has a way of repeating itself, so it is only a matter of time.  It may not be this month, year or decade, but a huge market crash and multi-year recovery process will happen again.