The Big Picture for the Week of August 22, 2010

The big personal finance story yesterday seemed to be that 22% of Fidelity 401k participants (not Fido's employees but employees of companies who use Fido for 401k admin services) have loans outstanding against their 401ks which is a high number. Felix Salmon dug a up a quote from someone at Fidelity who noted these loans are being taken to help meet financial hardships.

CNBC talked about this several times yesterday and there were also countless write ups on the internet as well. Also noted by Felix is that the 22% equates to 2.5 million people which strikes me as an astronomical number and that is just one service provider.

Somehow the model for prudent behavior broke down and while that is not a shock to any of you the conversation about all these 401k loans outstanding raises some serious questions about the fate of many Americans personal-finance fate. No 401k, no social security and a lot of debt is a very bad place to wind up at age 63.

I say no social security but what I mean is a means test that will make it more like a welfare program based on how much was earned--let's hope I'm being overly harsh. As far as no 401k let me share an anecdote that befell a friend about ten years ago. He had a loan out against his 401k, got laid off and could not repay the loan which created a tax liability that took several years to clear. While I am not certain about the details of paying off the tax liability, if he was not contributing to his 401k as he was paying the IRS (which is plausible) and never paid back the loan, just the tax (which is also plausible), then he set his financial plan back many years.

Will there be more layoffs that put some of the 401k participants with loans in the same boat as my friend? If so how many of them will follow a path of paying off the IRS, never paying back the loan and not saving while the IRS is being paid? This scenario assumes the person in question can find a job which my friend was able to do back then.

If we generically label the loan phenomena as poor use of the product (I concede that is unfair and there are real hardships that come along) well that is only one aspect of the typical person's financial life. What about credit cards? Here is one link that says the "average household in America with one or more credit cards has nearly $11,000 in credit-card debt." If we assume that number is close to right then it becomes difficult to draw any positive conclusions there either and if we include HELOCs in the this part of the conversation it looks even worse. We've all read more than we've wanted about the extent to which people have also mismanaged their mortgages as well (yes there was predatory lending). Not addressed above or in anything I read or heard about the 401k loans is whether people contribute enough into their 401ks which is a whole other issue.

Obviously this points to financial literacy which has come up before but if we collectively are not financially literate, and behaviors suggest we are not, then for now we just sit around and talk about what we should (save more) and should not (use credit cards) do which does not appear to be very effective but at some point will come the consequence for our collective financial illiteracy.

I have no idea what the fallout will be or what the attempted fixes will be but I would suggest not counting on whatever safety nets (social security or pension) you think you have coming to you. In that light where do you stand? If you don't like the answer then you need to figure out how to fix it on your own. Posts like this often draw criticism for being harsh or "forgetting" about certain circumstances that make what I talk about very difficult to actually do. That is fair enough but I would ask what conclusions do you draw about the math involved in these various things? If any of them are ever going to be actually fixed can you envision a fix that isn't "unfair" to a lot of people? Action taken now to change personal behaviors will mitigate the consequences of "unfair."

Every aspect of someone's financial life is made much easier but having as small a nut as possible. Not having debt is a good way to get the overhead down and obviously oversaving (if there is such a thing) creates a greater margin for error like covering unexpected emergencies or at least partially covering them. I repeat this general theme often because obviously this is important and also hope that it creates more conversations for people which might have a positive impact on the problems that some people have.