Be Wary Of Easy Answers To Hard Problems
- Why it's a horrible idea to spend your retirement accounts early.
- The common belief most investors have about active trading… that's dangerously wrong!
- Know the truth behind the statistic before jumping into active trading.
A reader asks…
“…I'm an architect suffering under this dreadful economy like so many of us are, and I need to do something to help carry me through… What I'd like to do is use a portion of my IRA funds to educate myself further in the investment arena, pay back the loan, and use the remainder of the IRA to actively invest for income and growth. In other words, keep a portion of the earnings to supplement my income and reinvest the rest for growth. Does that sound like a reasonable idea?”
To paraphrase the question I'm really hearing two separate questions…
- Is it okay to spend (or borrow) retirement assets as an expedient way to accomplish an objective prior to retirement?
- Is it reasonable to take up active trading as a way to increase investment return to supplement current income and still grow my IRA?
My short answer to both these questions is “no” and “no,” and I'll explain why below…
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Is It Okay To Spend Retirement Assets?
The number of situations in which it's acceptable to withdraw money from your IRA accounts prior to retirement can be counted on one hand with fingers left over.
It's generally almost always a bad idea. You'll pay penalties, taxes, and do irreparable damage to the compound growth necessary to fund retirement.
The reason people raid their retirement fund for current spending is because it's easy. It's money they have access to which provides an expedient solution to a pressing problem.
Alternative solutions can nearly always be found, but they're also more difficult… IN THE SHORT RUN.
But in the long run, spending your retirement accounts is usually the worst solution and should be avoided.
In summary, you should always try to avoid spending retirement accounts until you actually retire. There's usually a better long-term solution, even if it's more difficult right now.
Regarding the active trading question, my concern is there may be a false belief about what's possible with active trading.
While I support active trading as a risk management tool, there are a lot of hucksters making unrealistic claims of high returns to promote their active investing courses. Don't believe them.
Active trading isn't nearly as effective at increasing returns net of expenses as it is at lowering risk. It's very realistic to expect a better risk-adjusted return, but don't expect to knock the ball out of the park just because you take an active investment approach.
And BTW, you could do much worse than the passive approach if you make certain common mistakes. Improved returns only come to those with excellent skill.
If you're not sure whether to believe me or the hucksters marketing the courses, then I suggest studying the returns of hedge funds with special note on the percentage of funds that fail (a database without survivorship bias).
Hedge funds attract the best and brightest of active trading; yet, the results aren't impressive over the long term.
It's exceedingly rare to earn better than a 1:1 risk to reward ratio over the long term (net of expenses and taxes).
Sure, there are stars every year with amazing investment results, but over the long-term, you'll find very few who produce better than a 1:1 risk/reward ratio.
What that means is that depending on the size of your IRA and your particular abilities in active trading, it may not be realistic to supplement current income and still build retirement security from the same account.
There may not be enough to go around net of inflation and growth requirements (not to mention the penalties and taxes associated with premature distributions).
I'm sorry, but it isn't as easy as all the promoters make it sound. Active trading is great for risk management, but don't expect outsized returns over the long-term.
My suggestion is if you want to take up active trading that's fine, but recognize it has a learning curve like any other profession.
Set realistic time and training expectations. Keep your day job because it's not a slam dunk (despite what the huckster promoters may claim).
Don't spend your IRA money – figure out another way to accomplish the objective.
If you're truly committed to this path (which you will need to be in order to succeed), then you'll find another solution.
In other words, there's nothing inherently wrong with your overall objective – to become an active trader and to figure out solutions to your economic difficulties. I would just be careful how you implement these solutions to protect yourself from the downside risk.
My two cents worth…
Let me know your two cents worth in the comments below. What do you think of his question and what do you think of my advice?
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