The Worst Way to Celebrate Your Higher 401(k) Balance

In this "What's Up, Bro" segment from this episode of Motley Fool Answers, Alison Southwick and Robert Brokamp consider the disturbing trend of people raiding their 401(k) accounts to splurge on everything from vacations to cars. But no matter how flush you're feeling when you look at that retirement account balance, if you're not actually retired, that withdrawal is probably the wrong move.

A full transcript follows the video.

This video was recorded on Feb. 6, 2018.

Alison Southwick: Hey, Bro, what's up?

Robert Brokamp: Hi, Alison! Yes, today we're going to talk a little bit about the 401(k) games people play.

We all know the stock market has been doing very well. Many people have 401(k) balances that are looking pretty good these days. I ran across an article that was in The Washington Post called "Hold tight or splurge? Booming retirement accounts are making that a tough question." The article is by Todd Frankel and Thomas Heath.

What they did was, among other things, talked to a few financial advisors and got some interesting stories about what people want to do with their new 401(k)s. For example, take out $20,000 for a vacation. And because this person isn't 59 1/2, they're paying taxes and the 10% penalty. Another person wanted to take out $75,000 to give as a loan to their son to buy a house. The article quoted a financial advisor named Jamie Cox who works for Richmond-based Harris Financial Group. He said, "I've seen more money requests for extraneous items in the last six weeks than I have in the last five years."

This is something probably attributable to something economists call the "wealth effect." People want to spend more as their wealth goes up. There's evidence about this...

Southwick: It also just makes sense.

Brokamp: It does.

Southwick: I don't know that a behavioral economist really needs to sit on this one for a while.

Brokamp: It does. It does makes sense, to a certain degree, as long as it is responsible. It's been noticed that when their financial wealth goes up, meaning stocks, it's probably even stronger. The evidence adjusts when it comes to your house. One study found that for every dollar your house increases in value, your spending goes up six cents.

Southwick: OK.

Brokamp: And it goes the other way, too. Another study found that for every dollar that your house drops, you've cut your spending by 10% or 10 cents. So, to a certain degree it does make sense, but it obviously goes overboard.

Raiding your 401(k) before you're retired, just because it's gone up, doesn't necessarily make a lot of sense, and there are other wacky things that happen when the good times are still rolling. For example, the savings rate goes down. Just recently, the Bureau of Economic Analysis showed that the U.S. savings rate fell to 2.4%...

Southwick: Wow!

Brokamp: ... in December, and that is the lowest since 2005. Now the way they calculate the savings rate is a little funky. For example, if you buy a car, they assume that you just paid for the car right then and there but, of course, most people don't. They spread out the monthly payments over three to six years. But still, part of why the savings rate last month was low is because a lot of people went out and bought more cars.

Also, credit card debt is now over $1 trillion, the highest ever, according to the Federal Reserve. Good times are going, so why don't I borrow more money to spend more money? It doesn't quite make sense.

For me, whenever the market returns above-average returns, it's like a loan. We all know that the stock market returns, on average, 10% a year. Over the last five years the S&P 500 has returned, on average, almost 16% a year. At some point the market takes some of that back. To be spending your retirement money before your retirement at a time when the stock market is up, knowing full well that at some point it is going to go down again, just doesn't make a lot of sense.

Southwick: What's your advice to people to keep this in check? Because I imagine we are all guilty of this to some extent.

Brokamp: Right, and to a certain degree it's totally warranted.

Southwick: Said Rick, who just bought two guitars last week.

Rick Engdahl: And a harp.

Southwick: And a harp.

Brokamp: And a harp.

Southwick: I thought you rented the harp.

Engdahl: Rent to own.

Brokamp: I think that's fine. It's perfectly reasonable to enjoy some of the money you make. It's perfectly reasonable to even take some of your investment successes and enjoy them to a certain degree. To be taking money out of your 401(k) early to spend $20,000 on vacation...

Southwick: That's super dumb.

Brokamp: ... I think that's taking it overboard.

Southwick: See, you put it nicely. I say that's super dumb and you're like, "That may be a little extreme."