401(k) plans aren’t just for retirement

By Felix Salmon
August 20, 2010

One of the reasons that banks made so much money from overdraft fees is that people are naturally optimistic: they never think, when they open a checking account, that they’re going to go overdrawn very often. So overdraft fees aren’t a big deal to them at the time.

Much the same is true of retirement accounts like 401(k) plans. People load them up with stock-market investments, because they’re not going to touch the money until they retire, which is a long way off, and stocks tend to perform well over the long run. Financial advisers, similarly, tend to recommend stocks for the long run — and there’s nothing more long-run, for most people, than their 401(k) account.

Except in the real world it doesn’t work like that: Fidelity has just announced that by the end of the second quarter, 22% of its 401(k) participants had borrowed against their accounts. That’s about 2.5 million Americans right there:

“People have been looking to their 401(k) plans as a source of relief to help them meet financial hardships,” said Beth McHugh, a Fidelity vice president who oversees the area. “For many individuals that is their primary savings vehicle.”

The point here is that if your 401(k) plan is a savings vehicle which you’re going to use to help meet financial hardships, your risk appetite and asset allocation decisions are likely to be very different from what your financial adviser is probably telling you.

Even if you just take into account a 22% probability that you’ll need to tap your 401(k) before retirement, that should probably reduce the degree to which it’s invested in stocks. And that probability is low: 22% of Fidelity’s 401(k) plans have loans out against them right now. The number of the company’s plans which have ever had loans out against them is by definition substantially higher.

Very few people are so well off that they can be certain they’ll never need to tap their retirement funds before retirement. The rest of us should be a bit more realistic about that possibility, and invest accordingly.


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I’ve been fascinated by the ‘behavior gap’ ever since I ran across the Dalbar study that talks about the difference in average investment returns, and the returns the typical investor actually pockets:
http://www.behaviorgap.com/outperform-99 -of-your-neighbors/

Before the meltdown the average 20 year investment return was 11.8%, but the average *investor* return was 4.5%. The difference comes from our investment behavior – we sell when stocks are low and buy when they’re high, or as in this case invest in long-term securities whilst underestimating the probability that we’ll need that money in the short-term.

Of course there’s someone on the other side of all those transactions, which does make me wonder if the whole financial industry requires small investors to behave like idiots to survive?

Posted by petewarden | Report as abusive

The 401k is an outstanding source of funds for people. It’s a loan that must be paid back… to yourself… with interest.

I took out a loan for the downpayment to buy my first house and I’m happily living there dispite being 20%.

That original loan from my 401k will be paid off by the end of this year and I am planning on taking out another loan at that point to fully fund my 2010 contribution to my self directed IRA. The result is that I’ll have a huge tax return that I will fund my 2011 IRA contribution.

401k participation should be mandatory for all workers at 10% of wages. The default investment should be a fund of actively managed risk assets. Use low cost funds vanguard style. Start the program off at 2% of wages and step it up by 2% each year until you hit the 10%. If workers want to put in more that’s fine of course but there should be a minimum.

The U.S. retirement deficit, (the difference between what boomers have ACTUALLY saved and what they NEEDED to save to live the lifestyle they currently have) dwarfs the national debt of the goverment.

I’m so proud of my company… at our bank all new employees are automatically enrolled in the 401k plan… they have to opt out rather than opt in. Every company shoud do that… there shouldn’t even be an option to opt out… it should just be mandatory. Otherwise your just damming the stupid to a life of poverty in reitrement.

Posted by y2kurtus | Report as abusive

I have to quarrel with the sentence,”The number of the company‚Äôs plans which have ever had loans out against them is by definition substantially higher.” I imagine that, given the distressing times, the current number of 401(k) loans could dwarf historical norms; so that, even though I have to grant that the total number of any time series (that admits of no negative numbers) is by definition larger that any single data point in the series, I don’t grant that the assertion “substantially higher” is supported.

Posted by mutant_dog | Report as abusive

on a similar note… in Canada we can borrow money to contribute to RRSP (401k equivalent), get a tax refund and repay the loan. I would love to know how many people actually end up not paying the RRSP loan.

Posted by takloo | Report as abusive