Did Santa Claus come early this year?
After hitting lows for the year in early October, the stock market had a very pleasing bear market rally. For the months of October and November, the S&P 500 bounced up over 13%.
So far, December has been much less satisfying. The S&P 500 is down over 3% as I write.
Still, the month is young. Santa Claus could make an appearance like he usually does. In fact, according to MarketWatch, in December, the DJIA is up 71% of the time, the S&P 500 is up 73% of the time, and the NASDAQ is up 61% of the time.
But it’s not all hot cocoa and candy canes in December. If you recall, in December 2018 the S&P 500 dropped 9.2% to close out the year. In this respect, we see an important tailwind for stocks in December.
Specifically, year-to-date, the DJIA, S&P 500, and NASDAQ are down 7.04%, 16.84% and 29.17%, respectively. By this, 2022 provides fertile soils for tax-loss harvesting. For example, if you have more capital losses than gains, you may be able to use up to $3,000 a year to offset ordinary income on federal income taxes and carry over the rest to future years.
You may want to check with your accountant if tax-loss harvesting makes sense. Given the market’s year-to-date performance it’s likely other people will be doing this. Certainly, ta- loss harvesting could put downward pressure on the market through the end of the year.
No Savings, Maxed Out Credit Cards
For better or for worse, people’s retirements are predicated on the stock market. And, for some, this will lead to disappointment in their golden years. But what choice do they have?
A regular savings account is continuously eroded by the Federal Reserve’s inflation. Social Security is technically insolvent. Property investing has its own drawbacks. Yet people must somehow save and grow wealth.
Currently, the 401(k) is the primary retirement savings vehicle for most Americans. Here at the Economic Prism, we encourage readers to take advantage of their employer’s 401(k) plan, if available. However, this shouldn’t be your only form of savings.
You should also save, invest and grow wealth outside of a 401(k). That way, if you have an emergency, and you need quick cash, you don’t need to tap your retirement savings.
Unfortunately, many Americans do not have an emergency savings fund. Per data from the St. Louis Fed, the personal savings rate in October was just 2.3%. The only time it has ever been lower, dating back to 1959, was in July 2005, when it briefly touched 2.1%.
Naturally, to keep up with expenses, many Americans are turning to their trusty credit cards. Americans hold $925 billion in credit card debt, as of the third quarter of 2022, which is an increase of $38 billion since Q2 2022. The New York Fed noted this is a 15% year-over-year rise — the biggest jump we’ve seen in more than 20 years.
So, what’s a person to do if they have an emergency expense, yet they have no savings, and their credit cards are maxed out?
There’s only one choice: Raid your retirement account.
Hardship Withdrawals
According to Vanguard, more and more Americans need cash. And they need it quick. In fact, “hardship withdrawals” from 401(k) accounts are at an all-time high. Which is not good.
As of October, the current number of monthly hardship withdrawals at Vanguard is 0.5% of the total accounts. Obviously, this is a small number.
However, by comparison, that number was 0.2% in October 2020. In other words, the number of people taking hardship withdrawals has increased 150% over the last two years.
Hardship withdrawals from a 401(k) are a terrible way to make ends meet. And are only reserved for the most hard-up circumstances.
Hardship withdrawals are only permitted when they are to cover an ‘immediate and heavy financial need,’ according to IRS rules. Moreover, they are subject to income taxes and, if not done right, a 10 percent early withdrawal penalty.
Fiona Greig, Vanguard’s global head of investor research and policy, offered the following words on the matter:
“The recent increase in households drawing on their employer-sponsored retirement accounts, however, could be a sign of some deterioration in the financial health of the U.S. consumer.”
This assessment, without question, is most notable for its dramatic understatement. The fact is American household finances are stretched past the breaking point. They’re proving incapable of keeping up with high consumer price inflation. All it takes is one emergency, like a medical bill or a funeral expense, and everything snaps.
Yet emergencies like these are inevitable. They’re part of life. Something must be seriously wrong with the political economy when the best solution for managing them is through raiding one’s retirement account.
Have You Ever Raided Your Retirement Account?
No doubt, having an emergency savings fund, an account outside of a 401(k), has never been more important. Emergency expenses happen. They can be costly. Preparing for them is essential.
The problem with emergency expenses, if you aren’t prepared for them, is the situation quickly turns from an emergency into a crisis. And by then, reasonable solutions are out of the question.
Truly, this is a sorry state to be in. Yet it’s the reality for many Americans. This may even be your reality too. Where routine financial emergencies are triggers for crisis. Have you ever had to raid your retirement account?
Raiding your 401(k) to cover an emergency expense may offer an immediate solution. But the long-term consequences, with respect to investing and building retirement wealth, could be very destructive in the future.
Remember, one must have capital to invest in order to make investment returns. The power of compounding is negligible over the first several decades. Only much later does it snowball into something substantial.
Over many decades, someone of modest means and outstanding discipline can grow a small grubstake into a comfortable retirement. But not if they’re raiding their retirement savings every time there’s a financial emergency.
Social safety nets are already frayed at the edges. You can’t count on Washington to bail you out in your old age. Raiding your 401(k) during your working years practically guarantees you’ll be out of money when you need it most.
But there is some good news in all of this. If you’re of working age you still have choices. You can build an emergency fund outside of your 401(k) so that your retirement fund can grow without being touched.
There’s no time like the present. So why not get started today?
[Editor’s note: Saving, investing, and building investment wealth is extremely important. Though it has never been harder. If you’re looking for a few ideas on how to go about it I encourage you to check out the simple, practical steps everyday Americans can take to protect their wealth and financial privacy, which are documented in the Financial First Aid Kit. If you’d like to find out more about this important and unique publication, and how to acquire a copy, stop by here today!]