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Author: synchronicityII Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 308782  
Subject: Re: Problems with my Sentra Date: 9/29/2011 8:36 PM
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We want you to STOP taking out loans to funnel money into more stock investments. I could understand if money you set aside three years ago was still recovering and you didn't want to spend it. But you KEEP on funneling money into the stock market even though you have NO cash reserves. If you just took the money you invested in the last two years and instead had put it into a savings account, how much would you have?

Although my reading of 401kinvestor is that he has, in fact, made a string of poor financial decisions, at least some of which is attributable to his illness, I will take a slightly contrarian view in one respect.

Personally, I prefer pushing money into a 401K or similar tax-preferenced savings over paying down most credit card debt, and I also prefer aggressively paying down CC debt to putting money into an "emergency fund" or similar low interest savings.

Why? Well, first, regarding a 401K. If I have an "extra" $100, I could either A) put it into a 401K with no income taxes on it, or B) have that money taxed at the federal level (for most people here, I suspect this would be taxed at either a 15% or 25% rate) and state level (if applicable, let's assume a 5% state tax rate, approximately 4% effectively if state taxes can be deducted on one's federal return), and then take the ~$71-$81 and use that to pay down debt.

In general, I would prefer to take that $100 and put it into savings where it can also grow tax-deferred. Plus, if I am fortunate enough to increase my earnings or get some windfall I can always increase my debt payments, but one can't play "catch-up" with tax-preferenced savings from year to year.

As for the second issue, let's say I have 5K of credit card debt at 20% (15% or whatnot), and no "emergency fund". I get an additional 1K. I could put this in my emergency fund in case of car trouble or whatever (where it will collect say 1% at current rates) or use it to pay down my CC debt now.

Me, I would pay down the CC debt immediately. Why? Well, let's say that three months later I do have car trouble, and it costs $1K. "Ah ha" you say, "don't you wish you had an emergency fund?"

Well, no. Because, what would be the situation if I had an e-fund? I'd now have 5K of CC debt and no e-fund. Instead, I now have...er, 5K of CC debt, and no e-fund.

By leaving money in the e-fund instead of aggressively paying off high interest rate, I've effectively traded away the possibility of having to carry additional CC debt for the certainty of carrying higher CC debt. Money is fungible, so why should I leave existing funds at a higher interest rate?

That having been said, I do get the idea of learning good budgeting/financial practices, and if one tends to spend more than they earn and needs to build the habit of savings, then maybe the "set up an e-fund" strategy makes sense (assuming they also refrain from additional spending with their CC's). But it's important to realize that there's a cost involved with that. You're essentially paying a certain amount of money to establish that habit. If it's necessary than so be it, as "spending" the money may be worth it over the long haul if you're successfully reprogramming your spending/saving habits. But from a strictly quantitative perspective it's a sub-optimal strategy.

But then again, I suspect many people would completely disagree with my financial habits anyway.

-synchronicity
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