Do not take a loan out from your 401(k)…[/quote]
Why not? For the financially prudent a 401k loan can be a great deal and this opportunity may fit the bill.
Typical 401k loans allow you to take 50% of the balance, which is exactly what OP needs. You’ll probably pay around 5% interest back to yourself while you pay back the loan. The key is to not decrease your regular contribution to pay back the loan. If you can maintain your typical contribution rate and add in the after tax payback, the 401k loan is a great way to borrow from your retirement accounts instead of a bank.
OP, Can you maintain your regular contribution and make the payment to a 401k loan? Is the 401k loan an option to you?[/quote]
You will lose out on years of compounding interest, it has to be paid back within certain parameters, and the chances of losing the money on a small business investment are pretty high. That, imo, is a poor reason to borrow from you 401(k). The purpose of a 401(k) is retirement savings not high risk investing. I would only take a 401(k) loan out in an emergency situation my emergency fund can’t cover. That’s pretty much it. Not to buy a pool, not to buy a car, and not to invest in a business that will likely fail.
You’d have to do the math based on expected return … basically, if the IRR is 0 over the life of the loan compared to if you left the money in the 401k then it’s a wash (based on expected return rate which is really just an estimated guess). It’s a lot of work when a business loan of $20,000 will do and probably cost you less in the long run (in terms of lost returns).[/quote]
Sure, I would probably use NPV over IRR, but your point stands. The larger issue for me is the risk involved with the investment into a small business especially because OP has to pay the loan back and/or eat the penalty. If OP had $20K cash, I’d say go for it. [/quote]
Agree … It didn’t seem like the risk was much of a factor for the OP … I’m curious what the expected return on the business would be…i.e. opportunity costs[/quote]
For some reason I don’t think a lot of people consider the risks involved in something like this all that much.
I’d also want to know how long before my investment begins to pay off/out. It’s not uncommon for a small business to operate at a loss for the first year or two, finally break even, and then start to turn a profit. It could be 5 years (of lost interest) before the OP sees a return. [/quote]
Again agree … On average about 70 percent to 80 percent of businesses fail in 10 years (from Entrepreneur.com) That’s a lot of risk [b]BUT[/b] that’s also a lot of time to gain some great experience in the start up world/running a small biz.[/quote]
Ya, without a doubt.