Have you felt the holiday spirit in the air yet?
After experiencing a dip earlier this October, the stock market witnessed a promising bear market rally, with the S&P 500 surging by over 13 percent during October and November.
However, December has started on a less favorable note, with the S&P 500 declining by more than 3 percent thus far.
Yet, with the month still in its early days, there’s potential for a festive turnaround. Historically, MarketWatch notes that the DJIA rises 71 percent of the time in December, the S&P 500 sees gains 73 percent of the time, and the NASDAQ increases 61 percent of the time.
However, not all is merry and bright. Recall December 2018, when the S&P 500 plummeted by 9.2 percent as the year came to a close. This context serves as a crucial reminder of potential headwinds facing stocks this month.
To put things into perspective, year-to-date figures show the DJIA, S&P 500, and NASDAQ down by 7.04 percent, 16.84 percent, and 29.17 percent, respectively. Thus, 2022 presents ample opportunities for tax loss harvesting. If you have more capital losses than gains, you can offset up to $3,000 against ordinary income on your federal taxes, with the ability to carry over any excess to subsequent years.
Consulting with your accountant about tax loss harvesting can be beneficial. Given the current downturn, many individuals may be considering this option, which could exert downward pressure on markets as the year draws to a close.
Limited Savings, Overwhelming Debt
Whether good or bad, Americans’ financial futures heavily rely on the stock market, which may lead some to unmet expectations in retirement. But what alternatives do they have?
Traditional savings accounts are steadily losing value owing to inflation driven by the Fed. Social Security, too, poses concerns about its sustainability. While real estate can be a viable option, it comes with its own set of challenges. Still, people must find ways to save and accumulate wealth.
Presently, 401(k) plans serve as the primary vehicle for retirement savings for most Americans. At Economic Prism, we encourage readers to utilize their employer-sponsored 401(k) plans when available. Nevertheless, relying solely on a 401(k) is not advisable.
It’s equally important to save and invest outside your 401(k). This diversification ensures that in the event of an emergency requiring immediate cash, you won’t have to dip into your retirement savings.
Regrettably, many Americans lack an emergency savings fund. According to the St. Louis Fed, the personal savings rate fell to a mere 2.3 percent this October—only the second time since 1959 that it has dropped so low, the last instance being July 2005 at 2.1 percent.
As a result, countless Americans are turning to their credit cards to manage day-to-day expenses. Currently, the total credit card debt in the U.S. stands at $925 billion as of Q3 2022, reflecting a substantial $38 billion increase since Q2 2022. The New York Fed indicates this represents a 15 percent rise year-over-year—the largest increase in over two decades.
So, how does one cope with unexpected expenses when savings are nonexistent and credit cards are maxed out?
The only option often left is to raid retirement accounts.
Understanding Hardship Withdrawals
According to Vanguard, an increasing number of Americans are in dire need of cash, and they need it urgently. Hardship withdrawals from 401(k) plans have reached unprecedented levels, which is alarming.
As of October, hardship withdrawals accounted for 0.5 percent of total accounts at Vanguard— a seemingly minor figure. However, this was only 0.2 percent in October 2020, indicating a staggering 150 percent rise in the number of individuals utilizing this option over the past two years.
Generally, hardship withdrawals from a 401(k) are not a sound financial solution and should be reserved for the most critical situations.
These withdrawals are allowed solely to address an ‘immediate and heavy financial need,’ per IRS regulations. Moreover, they incur income taxes and potentially a 10 percent early withdrawal penalty if not executed correctly.
Fiona Greig, Vanguard’s global head of investor research and policy, commented:
“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 comment underscores a critical reality: American household finances are stretched to their limits, making it difficult to cope with rising inflation. When an emergency, such as a medical bill or funeral expense, arises, the situation can quickly spiral out of control.
These emergencies are unavoidable and part of everyday life, raising questions about the financial system when raiding retirement accounts becomes the primary solution.
Have You Ever Tapped Into Your Retirement Savings?
In this financially strained environment, maintaining an emergency savings fund outside of a 401(k) has never been more vital. Unexpected expenses are inevitable, and being prepared is crucial.
When individuals are unprepared for emergencies, the situation can escalate from a minor issue to a full-blown crisis, akin to the chaotic scenario of searching for lost items amid an intense struggle. By then, the options for resolution may be severely limited.
This reality is harsh, yet it represents the current situation for many Americans—an ongoing cycle where financial emergencies constantly trigger crises. Have you ever found yourself needing to raid your retirement account?
While withdrawing from your 401(k) might provide a quick fix for immediate expenses, the long-term implications for your retirement savings and wealth accumulation can be detrimental.
It’s essential to remember that to achieve investment returns, one needs capital. The power of compounding may seem minimal in the initial years but can yield substantial results over time. A disciplined individual can cultivate a small initial investment into a comfortable retirement over decades. However, frequent withdrawals for emergencies can thwart that growth.
The social safety net is already fraying. Depending on government assistance in your later years is a risky endeavor. Raiding your retirement savings can almost ensure that you will face financial challenges when you need support the most.
Fortunately, there is a silver lining. If you’re of working age, you still have the opportunity to create an emergency savings fund separate from your 401(k), allowing your retirement savings to grow unimpeded.
Now is the perfect time to begin this journey. Why wait any longer?
[Editor’s note: Saving, investing, and building wealth are crucial, and though the landscape has become increasingly challenging, there are actionable steps available for everyday Americans. For practical ideas on safeguarding your wealth and financial privacy, check out the Financial First Aid Kit. Explore this important resource today!]
Sincerely,
MN Gordon
for Economic Prism
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