I have been doing financial research and would love your opinion. I’m a young stay-at-home mom, and my husband just graduated from college. He got a great job within a few months of graduating, and we are looking toward buying a home. His job, also matches a 401k at 6%. We want to contribute all 6%, because we know that is a great perk. Especially considering we are 100% vested in both our portion and the company’s portion from day one. That does mean less saving for the down payment for the home though. Would you skip the 401k and save for the house, and then contribute once you have the home. Or would you contribute to the 401k and wait a little longer for the home? — Jen
You pose a dilemma that a lot of young people face, Jen. Do you participate in the 401k or save for a home? Of course, as I always say when I’m given one of these “what would you do?” scenarios, there is no right answer simply because everybody has different goals, values and opinions on where the future is headed.
That being said, if I was fresh out of college today and in a similar situation as you are now — and those were my only two options — my strategy would depend on what my vision of the future was. Here is my calculus when it comes to contributing to the 401k or saving for a home:
Scenario A. The politicians in Washington DC realize that the dollar is on the road to ruin and immediately cut the size of the federal government by half, sharply reducing expenditures. Initially there is a huge dislocation but, in time, and against all odds, real (not nominal) economic growth returns to levels not seen since the 20th century, led by a vibrant private sector unchained from the government yoke. The booming economy forces the Fed to normalize interest rates (i.e., even higher than they are now) in order to prevent overheating. The higher rates virtually eliminate all of the malinvestment that was previously harming the economy by stopping people from speculating with cheap money; the higher interest rates also encourage people to save once again. The sustained economic growth is so strong that the nation’s debt-to-GDP ratio eventually returns to a healthy level.
In this case, I’d contribute to the 401k up to the company match. Then wait a little longer for the home. Unfortunately, the United States’ finances are in such dire straits that the chance of this scenario occurring is slim.
Scenario B. Our bloated federal government continues expanding at breakneck speed, and the National Debt and unfunded liabilities continue to skyrocket. The economy limps along on massive deficit spending, and financial life support provided by the Fed in the form of artificially-low interest rates and the resultant currency printing, until: 1) the monetary base becomes so large that worldwide confidence in the US dollar is finally lost and hyperinflation takes root, quickly wiping out the hard-earned savings of everybody who failed to hedge their portfolios with wealth insurance; or 2) the powers-that-be finally see the writing on the wall and decide to preempt a collapse by devaluing the dollar — or start over with a new worldwide monetary system backed by gold or other tangible assets. Regardless, the end result is the same: sharply lower living standards for most Americans.
In this case, I would skip the 401k contributions and save for the house. When it came time to buy, I would put the minimum down, get a 30-year mortgage — or longer if I could find one — make the minimum monthly payments, and then retire the mortgage sometime in the future with sharply-devalued dollars.
Hi Len, I just read your article on using spreadsheets for personal financial situational awareness. I do use a self designed Excel sheet but your version has features that I really like. Is there a way to download the shell of the sheet you have designed? (No data, just formulas & pivot tables, etc.?) I love your weekly Black Coffee column. — Roger W.
Ask and you shall receive, Roger. I just sent a generic copy of my spreadsheet, so check your email. And thank you for being a weekly reader here!
If you have a question you’d like me to take a crack at answering, send it to: Len@LenPenzo.com — and please be sure to put “Mailbag” in the subject line.
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If I had to pick between 401K and buying a house, I would probably pick 401(k). And this is why-
There are lots of expenses associated with owning a house. All that money you currently spend in rent, is not completely wasted. When you own a home, everything that goes towards the mortgage interest, and everything that goes towards property taxes are gone. Forever. So compare that to your rent, and decide if it is worth buying. Add to it the cost of not getting 6% of salary (via employer match) per year.
Often, you can get away with renting a smaller home than the one you would buy. Because buying and selling homes are expensive, and you would want to stick with what you have for longer to amortize the cost. The 6% of salary that his employer matches 401(k) is free money. And the money you put in is before taxes. If you were to take it out, you would get much less in hand. Having 12% of your salary invested right in the beginning would increase a lot, thanks to compounding.
I agree, buying a home is not just a money decision – It is also emotional. Compute the costs of owning vs renting (you also spend a lot more on upkeep if you own!) and then decide if the difference is worth spending – emotionally. If it is, buy. Otherwise, just save what you can after you save in 401(k). Only you can make the decision.
Don’t listen to me or to Len. You have to make the decision.
” When you own a home, everything that goes towards the mortgage interest, and everything that goes towards property taxes are gone.”
And the counter to that is:
When you rent, you are paying the landlord’s mortgage interest and property taxes VIA the rent.
There is no free lunch.
Totally agree with that assessment, Ted. You beat me to the punch!
It’s the same story for corporate taxes. They too just get passed on to the consumer.
Also, it’s the same story for maintenance. The rent is either high enough to pay for it or the tenant doesn’t get it – the latter being the subject of horror stories, from time to time.
Amazing how many folks don’t get that corporate taxation is just really double taxing the shareholders.
“But corporations need to pay their fair share !!” Another load of baloney fed folks by politicians.
Corporations either spend their income on the ability to make/sell more/better stuff, (tax deductible) or they pass it on to shareholders, who THEN pay tax on that income.
ANYONE with half a brain would realize the very best way to attract all kinds of new business and JOBS to this country would be to simply eliminate the corporate income tax, sham that it is.
I agree I wasn’t clear. People generally assume that any money paid as rent is gone whereas any amount paid towards mortgage actually goes towards owning the house. I was just pointing out that it is not necessarily true, and only a small part of the mortgage actually goes towards the principal.
Agreed….initially most of a mortgage payment is lost to interest….but not 100%. And with each payment, unlike rent, more goes toward principal, generally building equity.
So say you rent for 10 years….you have zero equity. Had you bought 10 years ago, you’d have some at least….and if you live in an area where real estate is appreciating, you might have a LOT.
Also, if one wants to cut the amount of mortgage interest, add some to the payment each time…you can turn a 30 year mortgage into a 10-20 year version by simple paying the principal back a bit faster…..and saving a ton of interest in the process.
I’ve had two mortgages in my life…a 15yr one paid off in 7yrs, and a 20yr one paid off in 9yrs.
I’m not a fan of renting or interest…..though both have their place/time in this world, neither should be a long term plan in my opinion.
Mortgage principal reduction can be modified by doubling up payments, paying bi-weekly, or doing lump sum payments on anniversary date (once per year). It goes right on the principal. Like TNandy below, I too have had two mortgages in my life and paid them both off in similar fashion. And last, when I was planning to relocate/retire to present home I took out a Heloc and bought elsewhere, then sold the paid off home and bought more property. I built a rental cottage on property with saved cash and now use the rent to pay all taxes and insurance on all three properties. I do all maintenance and to this day would rather build and fix than waste time in a gym or on an exercise machine. I charge 50% off the going rate for rent for selected tenants, and when asked why one day, I said, “Because I can”.
We operate thus because I started out working life in the late 70s and 80s and enjoyed 18% interest rates and a layoff with young kids and wife at home. It was brutal. Never again. I would not impose that on any tenant whatever current trends allow as normal.
Owning a house outright allowed my wife and I to retire in our 50s. My brother in law, who would often argue in defense of his American mortgage interest deduction and investments as touted by his financial advisor…… and who was also a highly trained professional and very well paid, worked until he was 72. The difference between us was making mortgage payments and needing employer paid health insurance. Owning a house outright slows down the treadmill so you can jump off when you choose.
And as an old co-worker used to say, “When sugar turns to sh## ” it’s nice to have options.
No cookie cutter answer can apply. I assume you have no debt. If you do, pay off the debt first. A big factor in this decision is the time frame of this job and where you live. If you feel your husband may be transferred within a couple years or less (or change jobs requiring a move), investing into the 401k makes more sense now. As BusyMom says, the expenses with buying and selling a home are not cheap. You could expect to pay at least 6% in costs to sell it (if using a realtor). Most houses increase in value at about 3-4% per year (this is where location matters; this could be much higher or lower regionally). To overcome the selling expense (using say 3% net value increase), you would have to live in the house for at least 2 years – just to break even. If you plan to stay longer term in the area, saving for the house first makes sense. I advise saving 20% down to avoid PMI. My advice to younger people is to put a stake in the ground (real estate) IF the plan is to stay mid to long term in the area. Typically, you’ll find that with a mortgage and escrow it’s cheaper to own than to rent plus you begin to build equity.
Len, I recently found your blog, and just want to say that I really enjoy it. Like Roger, i especially look forward to the weekly Black Coffee articles.
Also, can you send me a copy of your spreadsheet?
Thank you, Nancy. Check your email for the spreadsheet.
Homes are overpriced almost everywhere and beyond levels of the last housing bubble in 07 and 08. But stocks and bonds are in the same boat. No easy answer.