Dear Penny: Should I Cash Out My Retirement at 28 to Prep for a Crash?

A man buries money in his backyard in this photo illustration.
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Dear Penny,

I’m a 28-year-old single man with about $100,000 in investments between my 401(k) and Roth IRA. I follow the news closely. Between COVID, our political situation and climate change, I believe the stock market is bound to crash again.

The amount I owe on my mortgage is right around $100,000, as well. What I’m wondering is, should I withdraw my investments now and use it to pay off my mortgage? The way I look at it, the stock market is basically gambling, but there’s a guaranteed return if I use it to pay off my house because of the money I’ll be saving on interest. 

I have no other debt besides my mortgage. Is this a good strategy?

-Prepping for a Crash

Dear Prepping,

The fact that you’re a 28-year-old homeowner with $100,000 in retirement savings tells me you’ve made smart decisions with your money. But even smart people have bad ideas on occasion. This is one of those times.

You’re right that the stock market is going to crash again because crashes are completely normal. The stock market undergoes a correction — meaning it drops by 10% or more — a little less than once every two years. A bear market, defined as a 20% decline, happens roughly once every seven. Historically, the market has always recovered over time.

My advice to you would be a lot different if you were 58 or 68. That doesn’t mean I’d tell you to panic and sell off all your investments if you were older, but I’d want you to look carefully at how much risk you’re taking, lest you need your money before that recovery happens.

But you’re 28. You probably have three or four decades left until retirement, which means your investments have plenty of time to recover from the inevitable dips and valleys.

Withdrawing your retirement money at 28 is like creating your own personal stock market crash, even if the stock market soars. You’ll pay a 10% early withdrawal penalty on money you take from your 401(k) plan, plus any Roth IRA earnings you touch. Add in the tax bill, and the blow to your net worth could be much harsher than the temporary damage from a crash.

Because of the taxes and penalties, you’ll need way more than $100,000 to pay off that $100,000 mortgage. You’d also be trading off 10% average annual returns in the stock market to save on a debt that you could easily pay less than 3% for at current mortgage rates.

And yet, I get why you’re tempted to do what you’re suggesting. In unpredictable times, we all want certainty. If you’re focusing only on the next few months or years, paying off your house seems like a solid bet because you get the certainty of not having a mortgage payment. Meanwhile, the stock market is a gamble if you invest based on daily fluctuations. On any given day, investing in the S&P 500 index has a 53% of generating positive returns — meaning it’s slightly better than a crapshoot.

Over the longer term, your chances of success are much higher. In a 10-year period, you’ll get positive returns 94% of the time. And at no point in the S&P 500’s history would you have lost money if you kept the money invested for 20 years, even if you invested at the market’s peak and sold after a crash.

Let’s focus on what you can control in these crazy times, and the stock market isn’t one of them. What you can do is make the next crash as painless as possible for you. The best way to do that is to build an emergency fund that could cover your expenses for at least six months. That way, you won’t need to tap your investments if you need cash right after the market tanked.

One thing to keep in mind is that the stock market only shows what investors think will happen, not the reality of what’s happening. How many times this year have we seen the stock market rally, even while the world seemed on the verge of implosion?

COVID-19, American politics and climate change all present very real reasons to worry. But don’t assume that people spouting off about what that means for the stock market know anything more than you.

If losing money truly keeps you up at night, I’d suggest you review the risk tolerance questionnaires you probably filled out when you opened your 401(k) and IRA. Your answers are used to determine how aggressively your money is invested. Make sure the answers you chose accurately reflect how you feel about the possibility of short-term losses. You normally want to invest aggressively in your 20s and 30s. But if the idea of a crash causes you major anxiety, it may be worth sacrificing higher returns for your peace of mind.

Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. Send your tricky money questions to [email protected].