throwing not just caution to the wind, but also their long-term financial stability.
Way, way back in 1978, Congress enacted the Revenue Act to help encourage Americans to save more for retirement. The Act allows Americans to save for retirement while, at the same time, lowering their state and federal taxes. The term “401(k)” refers to the section number and paragraph in the Internal Revenue Code: section 401, paragraph (k).
The most widely used investment vehicle, your 401(k) is a long-term diversified investment strategy designed to (ideally) minimize risk while helping you realize your retirement goals. With a 401(k), you make money on long-term investing in a diversified portfolio that takes advantage of capital gains growth and compound interest.
As an added incentive, many employers will match your contribution. In 2013, employees can tuck $17,500 away in their account, and those over 50 years old can put away an additional $5,500.
While plunking down a solid portion of every paycheck into your 401(k) may take discipline, you do so because you want to have some sort of safety net when you retire, which is a long-term strategy. Too many investors, however, are tired of the returns they’re seeing with their 401(k)s, especially in light of the major strides the S&P 500 (NYSEARCA:SPY) and Dow Jones Industrial Average (NYSEARCA:DIA) are making.
In an effort to chase higher returns on their 401(k)s, many investors are now tapping into it for day trading purposes. This is a recipe for disaster, despite what some unregulated so-called advisory services suggest. While some report spectacular gains, much of their data is based on “back-tested” or “simulated” results. And we can all look like financial gurus in hindsight—especially if we were able to time the market highs and lows perfectly!
When it comes to day trading your 401(k), you really are going to find it hard to beat the markets. Day trading is about trying to speculate price movement, and thanks to financial innovation, high-frequency trading algorithms, and armies of specialized traders armed with mountains of data and proprietary programs, it’s difficult for retail investors to capitalize on volatility.
Speaking of volatility, one of the so-called joys of day trading is finding stocks to short. For better or worse, the Internal Revenue Service (IRS) does not allow you to short from a self-directed individual retirement account (IRA) for tax reasons. If you really want to short the market, it’s probably a better idea to use your non-401(k) designated investing money and consider an exchange-traded fund (ETF) that shorts the entire S&P 500. For example, the ProShares UltraPro Short S&P 500 (NYSEARCA:SPXU) seeks a return that corresponds to three times the inverse (-3x) of the daily performance of the S&P 500. (Source: “Internal Revenue Bulletin: 2004-8,” U.S. Internal Revenue Service web site, February 23, 2004.)
Part of a long-term strategy with a 401(k) is about reinvesting dividends. You don’t get this when you day trade with your retirement; that’s because you haven’t left your money in the stock long enough to collect on those quarterly dividends.
While socking away money into your 401(k) for 20, 30, or 40 years doesn’t sound very exciting, the end result should be. Over the ensuing decades, capital appreciation and dividend growth in your 401(k) should reward patient investors with more than the volatile results that day trading would.
This article is brought to you courtesy of John Whitefoot from the Daily Gains Letter.