How to Make Your Best Investment Opportunity Even Better

November 25th, 2009 by Al Lewis (alewis)

Even though interest rates on taxable savings accounts have fallen to a level that can only be seen with an electron microscope, interest rates on other risk-free investments have, for many people, reached record levels of 29-33%/year – tax-free!

OK, what you are about to read is already in OOBonomics but if I had known the credit card companies were going to ream everyone with rates as high as 33% after tax (the equivalent of more than 50% pretax for some people), I would have made it the first chapter. 

Here is the policy idea:  People should be allowed a one-time zero-interest opportunity to borrow from their own 401K, and pay it back over (for instance) six years.

Assume for a minute your credit card rate is “only” 17% and your outstanding balance is $7000, which is the average.  If you make the minimum payment for six years on your card, at the end of that time you will still owe $7000. All that effort and nothing to show for it.   Call that the Sisyphus plan. 

Contrast that with our proposal to create an OOBonomic plan.  You borrow the money from your 401K with zero interest.  You then make the exact same payments you would have made to the credit card company under the Sisyphus plan.  The difference is that – assuming 17% interest —  six years later you have paid off your entire debt. 

At what cost to you?  Maybe 3% a year in foregone interest on your 401k. 

And what if you don’t make the payments?  What if a couple of years into it, you default?  Amazingly, even with the tax penalty, you are still somewhat ahead of the game.  That’s how big the arbitrage opportunity is.

For years, financial planners have made the obvious observation that paying off credit cards is the best investment people can make, but until very recently (last quarter credit card debt declined), those planners have been ignored.   By making this one simple OOBonomic change to the 401K law, the government can shine a light on this opportunity, relieving many people of a usurious burden and lowering the credit card default rate.

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One Response to “How to Make Your Best Investment Opportunity Even Better”

  1. Tooz Says:

    Having changed employers within the last three years, I have more in my IRA than in my 401K… If I could move funds into my 401k from my IRA, I could take a loan, paying myself interest.
    Even better, a loan from my IRA would allow me to pay off my credit cards and pay myself interest instead of their loan-shark-like 22% (it was increased from 11% to 22% without any late or missed payments).
    How about adding that to your idea, Al?

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