IS THE MATTRESS A GOOD PLACE FOR MONEY?
September 23, 2009
In fall 2008, the stock market suffered a severe decline. Fear prompted a number of individuals to suspend contributions to their 401(k) retirement accounts. They reasoned that holding the money and having it retain its face value was preferable to putting it in a money-losing investment. Even employees who were invested in bonds, rather than equities, stopped contributing. Some companies temporarily suspended their matching contributions.
Hiding money in a mattress was common following the 1929 stock market crash. In today's world, a worker simply stops contributing to his 401(k). A smarter plan is to continue investing in the market, says Pamela Villarreal, a senior policy analyst with the National Center for Policy Analysis.
How much could a worker have earned on nine consecutive monthly contributions of $100 ($900 total)?
- A $100 a month (tax-deferred) contribution to an S&P index fund (Fidelity) beginning December 1, 2008, would have yielded $1,078.62 by August 31, 2009.
- The same contribution to a bond index fund (Fidelity) would have yielded $939.97 by the end of the period.
- A $100 a month (taxable) contribution to a savings account invested in money market funds would have yielded $678.61 by August 31, including losses to the federal income tax, assuming a marginal income tax rate of 25 percent.
- Finally, hiding the money under the mattress would have yielded a 0 percent rate of return and it would have incurred federal income taxes, reducing the $900 to $675 by the end of the period, assuming a 25 percent marginal tax rate.
It is also important to note that after-tax contributions to a Roth 401(k) retirement plan will earn more than money left at home, notes Villarreal. For instance:
- An after-tax contribution of $75 a month (total $675) to a Roth 401(k) in the Fidelity Spartan Stock Index fund would yield $891.29.
- Contributing $75 a month (total $675) to a Roth 401(k) in the Fidelity Bond Index fund would yield $704.98.
Despite the bad news, Employee Benefit Research Institute (EBRI) reports that the average balance in 401(k) accounts with the fewest years of contributions (6 to 10 years) more than tripled between January 1, 2000, and January 20, 2009. Long-established accounts (21 to 30 years) gained at least 29 percent during the period. These results demonstrate that the best strategy for any saver is to keep investing, says Villarreal.
Source: Pamela Villarreal, "Is the Mattress a Good Place for Money?" National Center for Policy Analysis, Brief Analysis No. 677, September 23, 2009.
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