investment

Reviewed by Somer Anderson
Fact checked by Kirsten Rohrs Schmitt

An asset bubble occurs when the price of an asset, such as stocks, bonds, real estate, or commodities, rises rapidly without the underlying fundamentals to justify the price spike. The inevitable collapse wipes out the net worth of investors and causes exposed businesses to fail, potentially beginning a cascade of debt deflation and financial panic that can spread to other parts of the economy. This can result in a period of higher unemployment and lower production that characterizes a recession.

Asset price bubbles shoulder the blame for some of the most devastating recessions in history. The stock market bubble of the 1920s, the dot-com bubble of the 1990s, and the real estate bubble of the 2000s were asset bubbles followed by sharp economic downturns.

Key Takeaways

• Asset bubbles are formed when market prices in some sectors increase over time and trade far higher than the fundamentals would suggest.
• An expansion of the supply of money and credit in an economy provides the necessary fuel for bubbles.
• Technological factors, incentives created by public policies, and the particular historical circumstances around a given bubble help to determine which asset classes and industries are the focus of a bubble.
• Market psychology and emotions like greed and herding instincts may magnify the bubble further.
• When bubbles eventually burst, they tend to leave economic pain in their wake, such as a recession or a depression.

How an Asset Bubble Can Lead to a Recession

It is normal to see prices rise and fall over time as buyers and sellers discover and move toward equilibrium in a series of successive trades over time. It is normal to see prices overshoot (and undershoot) the prices implied by the fundamentals of supply and demand as this process proceeds, as has been readily demonstrated by economists in controlled experiments and classroom exercises. 

In actual markets, prices may always be either above or below the implicit equilibrium price at any given point as the fundamentals of supply and demand change over time while the price discovery process is simultaneously in motion. However, prices tend to seek or move toward the implicit equilibrium price over time as market participants gain experience and information about market fundamentals and the past series of prices.

What makes a bubble different is that the prices for a given class of assets or goods overshoot the implied market equilibrium price, remain persistently high, and even continue to climb rather than correct toward the expected equilibrium prices. This happens because of an increase in the supply of money and credit flowing into that market, which gives buyers the ability to continue to bid prices higher and higher.

Asset Price Bubbles

In an asset price bubble, new money entering the market keeps prices rising well beyond the fundamental value of the underlying assets implied by simple supply and demand.

When a central bank or other monetary authority expands the supply of money and credit in an economy, the new units of money always enter the economy at a specific point in time and into the hands of specific market participants, and then spread out gradually as the new money changes hands in successive transactions. Over time, this causes most or all prices to adjust upward, in the familiar process of price inflation, but this does not happen instantaneously to all prices.

Early recipients of the new money are thus able to bid up prices for the assets and goods that they purchase before prices in the rest of the economy rise. This is part of the economic phenomenon known as the Cantillon Effect. When buying activity in the market is focused on a specific asset class of assets or economic goods by the circumstances of the time, then the relative prices of those assets rise compared to other goods in the economy. This is what produces an asset price bubble.

The prices of these assets no longer reflect the real conditions of supply and demand relative to all other goods in the economy. Instead, they are driven higher by the Cantillon Effect of the new money entering the economy.

When an asset price begins rising at a rate appreciably higher than the broader market, opportunistic investors and speculators jump in and bid the price up even more. This leads to further speculation and further price increases not supported by market fundamentals. The mere expectation of future price appreciation in the bubble assets drives buyers to bid prices higher. The resulting flood of investment dollars into the asset pushes the price to even more inflated levels.

The real trouble starts when the asset bubble picks up so much speed that non-investors— effectively the last recipients of the newly created money as it trickles down to their wages and business income—take notice and decide that they, too, can profit from rising prices. At this point, prices throughout the economy already have begun to rise, as the new money has spread through the economy to reach the pockets of these non-investors. Because it is now circulating throughout the economy, the new money no longer has the power to continue pushing the relative prices of the bubble assets up compared with other goods and assets.

Early recipients of the new money sell to the latecomers, realizing outsized profits. These late buyers, however, realize little or no gains as the price bubble stalls for want of new money. The price bubble is no longer sustainable without additional injections of new money (or credit) by the central bank or monetary authority.

The bubble then begins to deflate. Other prices in the economy are rising to normalize the relative prices of the bubble assets, and no new money is entering the economy to fuel more bubble price rises, both of which also damp expectations of future bubble price appreciation. Late buyers are disappointed by lackluster gains, and the speculative optimism that magnified the bubble’s rise now reverses. Bubble prices begin to fall back toward those implied by market fundamentals.

The central bank or other monetary authority may at this point try to continue inflating the bubble by injecting more new money and repeating the process described above. Alternatively, after a sustained period of monetary injections and bubble inflation, it may cut back on injecting new money to tamp down consumer price and wage inflation. Sometimes a real economic shock, such as a spike in oil prices, helps trigger a cutback in monetary injections.

When the flow of new money stops, or even slows substantially, this can cause the asset bubble to burst. This sends prices falling precipitously and wreaks havoc for latecomers to the game, most of whom lose a large percentage of their investments. The bursting of the bubble is also the final realization of the Cantillon Effect. What unfolds is not just a change in relative prices on paper during the rise of the bubble, but a large-scale transfer of real wealth and income from the latecomers to the early recipients of the newly created money who started the bubble.

Redistribution of Wealth

This redistribution of wealth and income from late investors to the early recipients of newly created money and credit who got in on the ground floor is what makes the formation and collapse of asset price bubbles very much like a pyramid or Ponzi scheme.

When this process is driven by money in its modern form of a fiat currency mostly made of fractional reserve credit created by the central bank and the banking system, then the bursting of the bubble not only induces losses to the then-current holders of the bubble assets, but can also lead to a process of debt deflation that spreads beyond those exposed directly to the bubble assets to all other debtors as well. This means that any sufficiently large bubble can crash the entire economy into a recession under the right monetary conditions.

Historical Examples of Asset Bubbles

The biggest asset bubbles in recent history have been followed by deep recessions.

While the correlation between asset bubbles and recessions is irrefutable, economists debate the strength of the cause-and-effect relationship. Many argue that other economic factors may contribute to recessions, or that each recession is unique, so general causes can’t really be identified.

Some economists even dispute the existence of bubbles at all, arguing that large real economic shocks randomly knock the economy into a recession from time to time, independent of financial factors, and that price bubbles and crashes are simply the optimal market response to changing real fundamentals.

Broader agreement exists, however, that the bursting of an asset bubble has played at least some role in each of the following economic recessions.

1920s Stock Market Bubble/Great Depression

The 1920s began with a deep but short recession that gave way to a prolonged period of economic expansion. Lavish wealth, the kind depicted in F. Scott Fitzgerald’s The Great Gatsby, became an American mainstay during the so-called Roaring Twenties. The bubble started when the Federal Reserve eased credit requirements and lowered interest rates in the second half of 1921 through 1922, hoping to spur borrowing, increase the money supply, and stimulate the economy.

It worked, but too well. Consumers and businesses began taking on more debt than ever. By the middle of the decade, there was an additional $500 million in circulation compared with five years earlier. The Fed’s easy-money policies extended through most of the 1920s, and stock prices soared as a result of the new money flowing into the economy through the banking system.

The Roaring ’20s

The steady expansion of the supply of money and credit through the 1920s fueled a massive bubble in stock prices. Widespread adoption of the telephone and the shift from a majority-rural to a majority-urban population increased the appeal of more sophisticated savings and investment strategies such as stock ownership vs. traditionally popular savings accounts and life insurance policies.

The excess of the 1920s was fun while it lasted but far from sustainable. By 1929, cracks began to appear in the facade. The problem was that debt had fueled too much of the decade’s extravagance. The investors, the general public, and the banks eventually became skeptical that the continuous extension of new credit could go on forever, and began to cut back to protect themselves from the eventual speculative losses. Savvy investors, the ones tuned in to the idea that the good times were about to end, began profit taking. They locked in their gains, anticipating a coming market decline.

Before too long, a massive sell-off took hold. People and businesses began withdrawing their money at such a rate that the banks didn’t have the available capital to meet the requests. Debt deflation set in despite Fed attempts to reinflate. The rapidly worsening situation culminated with the crash of 1929, which led to the insolvency of several large banks due to bank runs.

The crash touched off the Great Depression, still known as the worst economic crisis in modern American history. While the official years of the Depression were from 1929 to 1939, the economy did not regain footing on a long-term basis until World War II ended in 1945.

1990s Dot-Com Bubble/Early 2000s Recession

In the year 1990, the words internet, web, and online did not even exist in the common lexicon. By 1999, they dominated the economy. The Nasdaq index, which tracks mostly tech-based stocks, hovered just above 710 in October 1990. By the turn of the century, it had soared past 6,700.

In 1995, the Fed began easing monetary policy to support the government bailout of the holders of Mexican bonds in response to the Mexican debt crisis. U.S. M2 money-supply growth quickly accelerated from less than 1% per year to more than 5% as the Fed began injecting new reserves into the banking system, peaking at over 8% by early 1999.

The new liquid credit that the Fed added to the economy began to flow into the emerging tech sector. As the Fed dropped interest rates starting in 1995, the Nasdaq began to take off, internet service provider Netscape launched its initial public offering (IPO), and the dot-com bubble began.   

Market Hype

The hype of new technologies can attract the flow of new money investment that leads to a bubble.

The internet changed the way the world lives and does business. Many robust companies launched during the dot-com bubble, such as Google, Yahoo, and Amazon. Accompanying these success stories, however, were several fly-by-night companies with no long-term vision, no innovation, and often no product at all. Because investors were swept up in the dot-com hype, these companies still attracted millions of investment dollars, with many even managing to go public without ever releasing a product to the market.

As wage and consumer price pressures mounted amid a flood of liquidity meant to combat the underwhelming effects of the Y2K bug, the Fed began cutting back money-supply growth and raising interest rates in early 2000. This pulled the rug out from under the Fed-fueled hype of the tech boom.

A Nasdaq sell-off in March 2000 marked the end of the dot-com bubble. The recession that followed was relatively shallow for the broader economy but devastating for the tech industry. The Bay Area in California, home to tech-heavy Silicon Valley, experienced a sharp rise in unemployment.

2000s Real Estate Bubble/Great Recession

Many factors coalesced to produce the 2000s real estate bubble. The biggest was monetary expansion leading to low interest rates and significantly relaxed lending standards.

The Fed dropped its target interest rate to successive historic lows from 2000 to mid-2004, and the M2 money supply grew an average of 6.5% per year. Federal housing policies under the general heading of the “ownership society” championed by then-President George W. Bush helped drive newly created credit into the housing sector, and deregulation of the financial sector allowed the multiplication of exotic new home-loan products and credit derivatives based on them.

As house-buying fever spread, lenders—particularly those in the high-risk arena known as subprime—began competing with each other on who could relax standards the most and attract the riskiest buyers. One loan product that best embodies the level of laxity reached by subprime lenders in the mid-2000s is the NINJA loan: no income, no job, or asset verification were required for approval.

For much of the 2000s, getting a mortgage was easier than getting approved to rent an apartment. As a result, demand for real estate surged. Real estate agents, builders, bankers, and mortgage brokers luxuriated in the excess, making piles of money as easily as the 1980s Wall Street “masters of the universe” portrayed in Tom Wolfe’s The Bonfire of the Vanities.

As one might expect, a bubble fueled in large part by the practice of lending hundreds of thousands of dollars to people unable to prove they had assets or even jobs was unsustainable. In certain parts of the country, such as Florida and Las Vegas, home prices began to tumble as early as 2006.

By 2008, the entire country was in full economic meltdown. Large banks, including the storied Lehman Brothers, became insolvent—a result of tying up too much money in securities backed by the aforementioned subprime mortgages. Housing prices tumbled by more than 50% in some areas. The resulting Great Recession crashed markets around the globe, put many millions out of work, and permanently reshaped the economy’s structure.

What Happens When the Market Is in a Bubble?

The clearest sign that a market is in a bubble is when assets trade for way more than what they are truly worth. A sudden surge in prices without any clear justifying factor generally suggests a bubble is underway.

What Happens When a Financial Bubble Bursts?

When the bubble bursts, prices tumble. Those who fail to sell before this happens can lose significant amounts of their invested capital, and companies may be forced to curtail spending and slash budgets. When the victims of a bubble are numerous, it can have a huge impact on the economy, sparking mass unemployment, reduced consumer spending, and debt deflation.

Asset bubbles are especially devastating for individuals and businesses who invest too late, meaning shortly before the bubble bursts. In this regard, asset price bubbles bear a similarity to Ponzi or pyramid scams.

How Do Bubbles Affect the Economy?

Bubbles affect the economy because they prompt members of the population to lose lots of money and often culminate in monetary policy being tightened. Widespread losses can create financial panic, erode spending, and trigger unmanageable debt.

The Bottom Line

The stock market bubble of the 1920s, the dot-com bubble of the 1990s, and the real estate bubble of the 2000s offer clear examples of how bullish investor sentiment can destroy economies and deepen inequality. While each of these bubbles has its own story, there are aspects that tie them together, including that they were driven by a flow of cheap money being pumped into the economy via monetary expansion and lower borrowing rates.

Eventually, policies are reversed, money dries up, and people begin realizing that assets are trading way beyond what they are truly worth. When this happens, the results can be catastrophic—for not just the participants but everyone in the economy.

Positive vs. Normative Economics: An Overview

Economics is a field that exists between scientific objectivity and subjective interpretation. Suppose a policymaker is trying to decide whether a proposed new tax is a good idea. One economist might advise, “This tax will likely increase government revenue by 10% per year,” while another says, “The government should use taxes to reduce inequality.” The first statement is factual—something that can tested. The second is an opinion rooted instead in values about what’s fair or right.

Thus, in economics, as in many other disciplines, it’s crucial to distinguish between descriptions of what is the case (“robberies are high in this city”) and what’s ethically right or should be the case (“stealing is wrong” or “robberies should be far lower”). For this reason, in the last 19th century, John Neville Keynes (the father of John Maynard Keynes) made the distinction between positive and normative economics by differentiating one as “the science of what is” vs. “the science of what ought to be.” Positive economics focuses on the former, making objective and testable economic analysis based on data; normative economics focuses on the latter, with value-based assessments and recommendations about desirable economic outcomes.

In theory, this might sound straightforward. However, it becomes more complicated in practice because economic analyses frequently mix elements of both. We dig into these complications below.

Key Takeaways

• Positive economics focuses on “what is.” This approach relies upon empirically verifiable statements about economic conditions.
• Normative economics focuses on “what should be.” This branch of economics includes value-based assertions.
• Testable positive statements help explain and predict world events, while normative statements can’t be tested by facts because they are about what ought to be the case.
• Practitioners often combine positive and normative economics in their work.

Positive Economics

Positive economics focuses on describing and explaining economic phenomena as they are. It’s supposed to be using models based on objective data. This is the part of economics that, since Adam Smith, has always aimed to be a science. Positive economic statements are specific and should be testable against evidence​.

The goal is to understand the workings of the economy without bringing in personal opinions or making moral judgments. For example, “Government-provided healthcare increases public expenditures” is a positive economic statement​: we can examine data from countries with socialized healthcare to see if public spending is indeed higher. But then, that seems to be the case definitionally. We’d want ultimately to conclude how efficient they are and what kinds of health outcomes different systems have so we can then say what kind of system we should have.

Because positive economics relies on data and observable facts, it avoids using loaded words like “should” or “ought to.” Policymakers rely on positive economics to answer questions like, “What will happen if we raise the gasoline tax?” or “How would increasing the minimum wage affect unemployment?”

The predictions made by economists tackling such questions describe likely outcomes without stating whether those outcomes would be good or bad. Instead, they help policymakers and economists understand how to achieve their goals: if a government aims to improve health outcomes, positive analysis can be used to answer fiscal and other outcomes in different healthcare systems.

Positive economics was popularized by the Nobel-prize-winning economist Milton Friedman, who argued that economics should be an objective science, free of personal bias or agenda-setting. Of course, he would become famous for long-running commentaries about policies he thought should be the case—that is, work in normative economics that he thought was grounded in his positive economics research.

Normative Economics

Normative economics focuses on values-laden perceptions of what are desirable vs. undesirable outcomes instead of analyzing factual data and cause-and-effect relationships. As such, it is often regarded as the “what ought to be” side of economics.

Normative statements reflect subjective viewpoints because they originate from individual values, cultural beliefs, and political ideals. The use of words like “should,” “ought,” “better,” and “worse” in normative economics suggests that they should be considered alongside other ethical and moral judgments.

One of the most notable proponents of normative economics is Amartya Sen, another Nobel Prize winner who has made major contributions to development economics.

Since normative economic statements reflect individual moral judgments, they can’t be validated or disproven by data analysis alone. For example, “The government should provide basic healthcare to all citizens” is a normative claim. This statement reflects a value judgment that considers universal healthcare a worthy ideal—a moral viewpoint.

Because of this, reasonable people can and often do disagree about normative economic statements even when they agree about the positive economic facts associated with them.

Positive Economics

• Positive statements require testing through observation and data analysis to determine their validity.

• Maintains value neutrality by concentrating on facts and evidence.

• Describes economic phenomena as they exist.

• Employs the scientific method.

Normative Economics

• Normative statements integrate ethical assessments and value judgments.

• Determines which policies should be implemented and defines desirable results.

• Presents recommendations that are grounded in specific goals or values.

• The same set of positive facts can lead to different normative conclusions based on individual values and priorities.

From Description to Prescription

The distinction between positive and normative economics highlights the dual nature of economics as both a science and a social discipline concerned with human welfare. While the two approaches differ fundamentally in their orientation and methodology, they are often taken as complementary rather than antagonistic. Indeed, effective economic analysis and policymaking typically involve elements of both.

Normative discussions about what the economy should aspire to depend on a factual foundation provided by positive economics. An understanding of economic systems and policy effects must precede meaningful debates about better economic policies.

Normative discussions can become detached from reality without accompanying positive economic analysis, which can result in good intentions producing harmful policy outcomes. Meanwhile, positive economics by itself often proves inadequate. Positive economic analysis at its most rigorous fails to define which policy objectives we need to prioritize or which trade-offs we should accept. Is economic growth more important than protecting the environment? Is it appropriate to support policies that create wealth at the expense of increasing social inequalities? Positive economics alone can’t answer these questions because they demand normative judgments about our values and priorities.

In addition, the way positive economics frames given sets of economic facts or has an interest in one area of the economy rather than others could mean norms are never too far away.

Important

Economists occasionally present normative conclusions as factual statements without intending to do so. Other times, economists may intentionally combine positive analysis with normative evaluation to nudge policymakers toward particular outcomes.

The Bottom Line

Both positive and normative economics are essential for analyzing and discussing contemporary economic matters. Positive economics establishes the factual basis for how the economy functions, while normative economics informs economic goals according to society’s moral ideals and priorities. 

Good policy decisions typically require both: A thorough, positive analysis combined with normative reasoning that identifies which outcomes should be pursued. 

Reviewed by Anthony Battle
Fact checked by Vikki Velasquez

Social Security is a federal program in the United States that provides taxpayers with certain benefits, including retirement and disability income.

Medicare, Medicaid, and death and survivorship benefits are also part of the Social Security program.

Social Security taxes are collected from most workers, regardless of whether they work for an employer or are self-employed. These taxes are used to fund Social Security benefits.

However, some American taxpayers may be exempt from paying Social Security taxes. Read on to learn who they are.

Key Takeaways

• People who work for certain religious groups may qualify for Social Security tax exemption if they and their groups are recognized as being officially opposed to Social Security benefits.
• Non-resident aliens may qualify for exemption based on the type of visa they have been issued.
• Current students who acquire college jobs that are contingent upon their college enrollment are eligible for a Social Security tax exemption on the income earned from those positions.
• Individuals who work for a foreign government may be exempt from Social Security taxes while working in an official capacity on official business.
• If you don’t pay Social Security taxes, you will not receive Social Security benefits.

Who Is Exempt From Social Security Taxes?

Members of Qualifying Religious Groups

Members of certain religious groups qualify for Social Security tax exemption. To claim such an exemption:

• You must waive your rights to all Social Security benefits, including hospital insurance.
• Your religious group, and you, must be officially opposed to public or private insurance plan benefits (including Social Security benefits) such as retirement, disability, and death benefits.
• You and your employer are members of such a religious group and your applications for exemption have been approved.
• Your religious group has been in existence continuously since Dec. 31, 1950.
• Your religious group can demonstrate that it has continuously made “reasonable provision” for its dependent members since Dec. 31, 1950.

Religious organizations and their members who desire exemption from Social Security taxes must apply for it by completing Form 4029.

Individuals who have qualified for Social Security benefits (even if these benefits were never utilized) will not be exempt.

Important

If you don’t pay Social Security taxes, you cannot receive Social Security benefits.

Non-Resident Aliens

Non-resident aliens (individuals who are not U.S. residents or citizens) usually pay Social Security taxes but may qualify for an exemption based on the type of visa they have been issued.

Non-residents with the following visas are exempt from paying Social Security taxes:

A visas

Foreign government employees (plus their families and household personnel) are exempt from paying taxes on the salaries they earn in their official capacities.

D visas

The crew on a ship or aircraft may be exempt if they serve on a foreign vessel and for a foreign employer, or if they serve outside the U.S.

F, J, M, and Q visas

Students, scholars, educators, trainees, researchers, and others in the U.S. temporarily are exempt from Social Security taxes on earnings if the work is allowed by the U.S. Citizenship and Immigration Services (USCIS) and it’s work that they entered the U.S. to carry out.

G visas

The employees of international organizations whose work takes place in the U.S. in their official employment capacity are exempt from paying Social Security taxes.

H visas

An H-2 non-resident who is a resident of the Philippines and who performs services in Guam is exempt from paying Social Security taxes.

So is an H-2A non-resident who comes to the U.S. temporarily to perform agricultural labor.

Certain other non-resident wages paid for specific types of work, such as ministry services and student nursing, are exempt as well.

Students With Jobs at Their Schools

A student who acquires a job at their university (or college) that’s tied to their continued enrollment is eligible for a Social Security tax exemption on the income earned from their job.

School employees who use an employee benefit to enroll at the university do not qualify.

Note

In 2025, if you do pay Social Security taxes, you only pay on income through $176,100. No tax is applied to income beyond that amount.

Foreign Government Employees

Individuals who work for a foreign government may be exempt from Social Security taxes while working on official business, if the applicable tax treaty provides for an exemption or the government meets the applicable U.S. law.

Their employees, spouses, children, and household personnel only qualify for the exemption if they are also employees of a foreign government.

In addition, an individual who works for an international organization may also qualify for the exemption from Social Security taxes, if the agreement that created the organization provides for an exemption or the organization meets the applicable U.S. law.

Why Would Someone Seek Exemption From Paying Social Security Taxes?

They might seek an exemption from the tax if they didn’t believe in the idea of Social Security (and waived their right to the benefits). Or, if they didn’t want their income reduced by an unnecessary tax, they might seek an exemption if they already had similar insurance in another country.

How Much Is the Social Security Tax?

The Social Security tax is 12.4%. Employers pay 6.2% for their employees, while the employee pays the other 6.2%. If you’re self-employed, you pay the entire 12.4% yourself and can deduct the employer’s share of 6.2% from your taxable income.

I Enrolled in College Tuition-Free Because I Work There. Am I Exempt from Social Security Taxes?

No, you must pay social security taxes because you are a “professional employee” of the college. If however, you enrolled in college, were offered a job there, and your job depended on you staying enrolled, you would be exempt from Social Security taxes.

The Bottom Line

Some individual wage-earners in the U.S. may qualify for an exemption from paying Social Security taxes.

This group of people consists of members of certain religious groups, non-resident aliens, students who have a job at the college at which they’re enrolled, and employees of foreign governments or international organizations.

Be sure to check on the requirements involved because even if you are one of those who qualifies, you may need to apply for the exemption to be recognized by the IRS as exempt.

In this episode of “The Deep Dive,” Dennis Moseley-Williams talks with host Jay Hummel about how advisors should think about the client experience today. Dennis argues that the shift to the “service versus experiences” model puts client well-being at the forefront. 

Most companies sell products and services, and the best create meaningful experiences. Dennis challenges leaders to rethink value, loyalty, and what customers truly want. 

Dennis Moseley-Williams:  An author, speaker, and experienced economy expert, Dennis teaches businesses to shift from transactions to transformation—competing on meaning, not price. He founded his company, DMW Strategic Consulting, in 2002 and resides in Ottawa, Ontario. 

A personal loan business can be a rather profitable enterprise. Instead of selling a product or service, you’d be providing something nearly everybody wants: access to money. However, getting a personal loan business off the ground requires some work. There are several steps you’ll need to take, such as forming a business entity, getting the necessary licenses and permits, and setting up an accounting system.

Key Takeaways

• Starting a personal loan business requires making a business plan, forming a legal entity, and securing licenses, an accounting system, and business insurance—among other steps.
• You can fund a personal loan business yourself or with the help of investors, or you can set up a peer-to-peer (P2P) lending platform.
• While a personal loan business can have expensive upfront costs and risks, it also enjoys a large market and high potential returns.

7 Steps to Starting a Personal Loan Business

1. Research the Market 

Before setting up shop, research the lending market for your target area or demographic. Understanding the current supply and demand can help you make better business decisions.

From there, analyze competitors and their interest rates, loan terms, and customer bases. The more you know what you’re up against, the easier it’ll be to strategize.

2. Put Together a Business Plan

Next, create a business plan that outlines how you’ll structure, fund, and market your personal loan business. Here are some sections you may want to include.

• Executive summary: This is a high-level summary of what your business will do and how it will operate and grow. It may also include a mission statement with your company’s values and goals.
• Products and services: Describe what types of personal loans your business will offer, such as secured or unsecured loans, installment loans, lines of credit, etc. Then outline what the customer journey will look like from initial contact to loan payoff. 
• Market analysis: Explain the current state of the industry and how you plan to capture market share from competitors. This is a good opportunity to summarize your findings from your market research.
• Marketing strategy: Lay out your plan to attract and retain customers, including the marketing and advertising channels you intend to use.
• Financial projections: Estimate your personal loan company’s finances in its first few years. This includes your expectations for revenue, operating costs, cash flow, and profit.

3. Decide Your Business’ Structure

Unless you opt to remain a sole proprietorship, you’ll need to create a legal entity to house your new business. This could be a limited liability company (LLC), partnership, or corporation, each of which changes how your business is taxed and your level of personal liability. Consult a legal or tax professional for guidance on which structure best suits your needs.

4. Register With the IRS

Depending on the type of business entity you form, you may need to get an employer identification number (EIN). This is a unique identifier assigned to your business by the Internal Revenue Service (IRS) for tax purposes.

5. Secure Necessary Licenses and Permits

Depending on where your business is located, there may be specific licenses or permits you’ll have to get. Visit the Nationwide Multistate Licensing System & Registry (NMLS) website to determine what you’ll need and start the relevant licensing and permitting processes. 

6. Purchase Accounting Software

As a personal lender, you’ll have to keep track of loans, payments, interest, expenses, wages, and other cash flows. Invest in robust accounting software to do this for you, and consider hiring a dedicated accountant to ensure your business stays compliant.

7. Purchase Business Insurance

Your personal loan business could get sued, suffer a cyber attack, or be liable for a worker’s injury. To protect against these and other risks, get business insurance.

The federal government already requires businesses with employees to have worker’s compensation, unemployment, and disability insurance. However, you may also want to invest in additional coverage, such as general liability, product liability, or professional liability.

How to Fund a Personal Loan Business

Now that you know the necessary steps for starting a personal loan business, let’s discuss one of the biggest hurdles: funding. After all, you need to have money before you can lend it to borrowers. 

Below are some common funding options:

• Your money: If you can bootstrap your personal loan business with your own money, you can keep full control over your profits, lending terms, and other business decisions (within regulatory limits). 
• Money from investors: A strong business plan may attract investors who will contribute capital in exchange for ownership stakes in the company. You’ll need to share the profits (and possibly decision-making authority) with them. However, you’ll have lower upfront costs and less risk.
• Peer-to-peer (P2P) lending: Instead of lending your or investors’ money, create a peer-to-peer (P2P) lending platform that connects borrowers with private lenders. Meanwhile, you get a share of the profits in exchange for your service.

Important

The biggest risk with a personal loan business is that some borrowers may not repay their debts. That’s why it’s crucial to set standards like a minimum credit score and then thoroughly vet borrowers by checking their credit, income, and existing debts.

Pros and Cons of a Personal Loan Business

Pros

• High profit potential

• Flexible business model

• Widespread demand

Cons

• Complex regulations

• High upfront costs

• Danger of borrowers failing to repay

Pros Explained

• High profit potential: You could, if you so choose, charge high interest and origination fees for an immediate and ongoing cash flow.
• Flexible business model: Thanks to digital transactions, you can run a personal loan business from virtually anywhere.
• Widespread demand: Plenty of people want the funding that personal loans can provide, resulting in a sizable market for your lending business.

Cons Explained

• Complex regulations: Financial and consumer protection laws can be strict and difficult to navigate.
• High upfront costs: Unless you raise substantial investor capital or opt for a P2P lending model, you’ll likely need a lot of money to start a personal loan business. 
• Danger of borrowers failing to repay: With every loan, you risk losing some or all of the money if the borrower misses payments or defaults.

Other Tips for Starting a Personal Loan Business

Before you launch your personal loan business, here are some final tips for success:

• Be prepared to work: Starting a personal loan business takes serious effort. Get ready for long hours and challenging business problems.
• Ensure you have sufficient capital: When you’re in the lending business, you need a lot of money—not just to lend out but also to keep in reserves.
• Protect sensitive data: As a lender, you’ll handle borrowers’ bank account numbers, Social Security numbers (SSNs), and other private information. Invest in data security professionals and software to ensure these are kept safe and secure.
• Set up a way to collect payments: That might be through a proprietary online portal, a third-party service, mail-in payments, or some other arrangement.
• Establish how you’ll collect on delinquent loans: Some borrowers will likely fall behind on payments. Put a process in place for collecting these delinquent loans.
• Understand local regulations: Lending is a highly regulated industry due to the large amounts of money and risk involved. Ensure you stay compliant to avoid legal issues.

The Bottom Line

A personal loan business can be a great way to make a high return on your money. However, you must ensure the business is set up correctly—with the right structure, licenses, funding, and borrower criteria.

Reviewed by Somer Anderson

There are many everyday habits that the average person can implement to protect themselves from the sting of a recession or even make it so that its effects aren’t felt at all. As the recession hits, these tools can help you get through it in one piece financially.

Key Takeaways

• Individuals can develop habits that will protect them ahead of time, even if an economic slowdown or recession takes hold.
• In terms of income, having an emergency fund, strong credit, multiple sources of income, and living within your means are all important.
• In terms of investments, individuals need to think long-term and diversify holdings, as well as be realistic about how much risk they can handle.

1. Have an Emergency Fund

If you have plenty of cash lying around in a high-interest, Federal Deposit Insurance Corp. (FDIC)-insured account, not only will your money retain its full value in times of market turmoil, but it will also be extremely liquid, giving you easy access to funds if you lose your job or are forced to take a pay cut.

Also, if you have your own cash, you will be less dependent on borrowing to cover unexpected costs or the loss of a job. Credit availability tends to dry up quickly when a recession hits. Once these things happen, use your emergency fund to cover necessary expenses, but keep your budget tight on discretionary spending in favor of making that emergency fund last and restoring it ASAP. 

2. Live Within Your Means

If you make it a habit to live within your means each and every day during the good times, you are less likely to go into debt when gas or food prices go up and more likely to adjust your spending in other areas to compensate.

Debt begets more debt when you can’t pay it off right away—if you think gas prices are high, wait until you’re paying a 29.99% annual percentage rate (APR) on them by fueling up on a credit card.

To take this principle to the next level, if you have a spouse and are a two-income family, see how close you can get to living off of only one spouse’s income. In good times, this tactic will allow you to save incredible amounts of money—how quickly could you pay off your mortgage, or how much earlier could you retire, if you had an extra $40,000 a year to save?

In bad times, if one spouse gets laid off, you’ll be OK because you’ll already be used to living on one income. Adding to your savings will stop temporarily, but your day-to-day frugal spending lifestyle can continue as normal.

Note

You’re only charged interest on credit cards if you don’t pay off your entire balance every month. So if you’re paying only the minimum amount required, your credit card debt will grow.

3. Have Additional Income

Even if you have a great full-time job, it’s not a bad idea to have a source of extra income on the side, whether it’s some consulting work or selling collectibles on eBay. More jobs mean more job security. Diversifying your streams of income is at least as important as diversifying your investments.

Once a recession hits, if you lose one stream of income, at least you still have the other one. You may not be making as much money as you were before, but every little bit helps. You may even come out the other end of the recession with a growing new business as the economy turns up.

4. Invest for the Long Term

So what if a drop in the market brings your investments down 15%? If you don’t sell, you won’t lose anything. The market is cyclical, and in the long run, you’ll have plenty of opportunities to sell high. In fact, if you buy when the market’s down, you might thank yourself later.

That being said, as you near retirement age, you should make sure that you have enough money in liquid, low-risk investments to retire on time and give the stock portion of your portfolio time to recover. Remember, you don’t need all of your retirement money when you retire—just a portion of it. It might be a bear market when you’re 66, but it could be a bull market by the time you’re 70.

5. Be Real About Risk Tolerance

Yes, investing gurus say that people in certain age brackets should have their portfolios allocated a certain way, but if you can’t sleep at night when your investments are down 15% for the year and the year isn’t even over, then you may need to change your asset allocation. Investments are supposed to provide you with a sense of financial security, not a sense of panic.

But wait—don’t sell anything while the market is down, or you’ll set those paper losses in stone. When market conditions improve, it is time to trade in some of your stocks for bonds or trade in some of your risky small-cap stocks for less volatile blue-chip stocks.

If you have extra cash available and want to adjust your asset allocation while the market is down, you may even be able to profit from infusing money into temporarily low-priced stocks with long-term value. Buy low so that you can sell stocks high later or hold on to them for the long run.

Be careful not to overestimate your risk tolerance, as that will cause you to make poor investment decisions. Even if you’re at an age where you’re “supposed to” have 80% in stocks and 20% in bonds, you’ll never see the returns that investment advisors intend if you sell when the market is down. These asset allocation suggestions are meant for people who can hang on for the ride.

6. Diversify Your Investments

If you don’t have all of your money in one place, your paper losses should be mitigated, making it less difficult emotionally to ride out the dips in the market. If you own a home and have a savings account, you already have a start: You have some money in real estate and some money in cash.

In particular, try to build a portfolio of investment pairs that aren’t strongly correlated, meaning that when one is up, the other is down, and vice versa (like stocks and bonds). This also means that you should consider asset classes and stocks in businesses that are unrelated to your primary occupation or income stream.

7. Keep Your Credit Score High

When credit markets tighten, if anyone is going to get approved for a mortgage, a credit card, or another type of loan, it will be those with excellent credit. Things like paying your bills on time, keeping your oldest credit cards open, and keeping your ratio of debt to available credit low will help keep your credit score high.

Important

Having a very good to exceptional credit ranges from 740 to 850. Try and stay within this range.

When times are tough, maintain communications with your creditors to keep them happy by making arrangements to keep your accounts in good standing. Many lenders and businesses would rather see you continue to be a customer than have to write off your account as bad debt.

What Is a Recession?

A recession means a significant decline in general economic activity. The macroeconomic term has traditionally been recognized as two consecutive quarters of decline, as reflected by gross domestic product (GDP) and other indicators such as unemployment. However, the National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity lasting more than a few months—normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales.

How Can I Prepare Financially for a Recession?

There are many everyday habits that you can implement to protect yourself ahead of time from the sting of a potential economic downturn or recession. Having an emergency fund, strong credit, multiple sources of income, and living within your means are all important tools that can help you get through a rough patch in the economy in one piece financially.

How Can I Make My Investment Portfolio More Resistant to a Recession?

In terms of investments, being prepared for a recession involves taking a long-term approach to your investment goals, diversifying your holdings, and remaining realistic about your risk tolerance.

The Bottom Line

The key to riding out a recession starts with planning for the worst-case scenario. Build up your emergency fund, pay off your high-interest debt, do what you can to live within your means, diversify your investments, invest for the long term, be honest with yourself about your risk tolerance, and keep an eye on your credit score. Once a recession does hit, it’s smart to look for a side gig to keep money coming in.

Deals worth over $100 billion each

Reviewed by David Kindness
Fact checked by Suzanne Kvilhaug

Vodaphone’s buyout of Mannesmann remains the largest corporate acquisition in history. The British telecom giant’s acquisition of the German company, which was completed in 2000, came with a multi-billion dollar price tag. To date, no other acquisition has topped it. We highlight some of the details of this major deal below, along with four of the other high-value acquisitions in global corporate history.

Key Takeaways

• The acquisition or takeover of one company by another is a key strategy for businesses that want to grow and increase their profitability.
• The biggest acquisitions have been valued at over $100 billion.
• The most highly-valued acquisition occurred in 2000 when Vodafone Group acquired Mannesmann AG.

Understanding Acquisitions

Acquisitions are financial transactions that occur when one company buys another. They are common in the corporate world—especially if the target is a promising business. Such acquisitions, also called takeovers, are usually executed as part of a company’s growth strategy and are made for any number of reasons.

The acquiring company may want to diversify into a new sector or product line, or it may want to increase its market share and geographical outreach, reduce competition, or profit from patents and licensing that may belong to the acquired target company. Such acquisitions occur at domestic as well as global levels.

The acquisition process can be a friendly one and generally involves purchasing a majority of the target company’s shares. In some cases, though, it may not be welcomed by the target. That’s when the acquiring company may take a more hostile approach to force the acquisition.

1. Vodafone’s Acquisition of Mannesmann AG

British multinational telecom company Vodafone Group (VOD) decided to buy German telecom giant Mannesmann AG in 1999. The long-running effort by Vodafone’s AirTouch PLC finally paid off in February 2000 when Mannesmann accepted its offer for a $180.95 billion acquisition, making the takeover the largest merger and acquisition (M&A) deal in history.

As the mobile market gained momentum across the globe and growth was at its peak, the large-value merger was expected to reshape the global telecommunications landscape. However, the deal was a failure and Vodafone was forced to write off billions of dollars in the following years.

2. America Online’s Acquisition of Time Warner

The $165 billion merger between America Online (AOL) and Time Warner comes in at number two in our list of biggest acquisitions in history.

The merger occurred at the height of the dotcom era in 2000 when successful internet provider, AOL, made a bid to acquire Time Warner. At the time, AOL had a massive market share and was looking to expand even further by tapping into Time Warner’s dominance in publishing, entertainment, and news.

But, the expected synergies of the merger never fully materialized. The two companies clashed in management style and culture. This was only exacerbated by the bursting of the dotcom bubble and the ensuing recession. The value of AOL stock plummeted. The two companies eventually parted ways, spinning off to operate as independent companies.

Note

An acquiring company effectively gains control over its target if it buys more than 50% of the company’s shares.

3. Verizon Communications’ Acquisition of Verizon Wireless

This next acquisition was worth $130 billion and took place in 2013 when Verizon Communications (VZ) took over Verizon Wireless. Verizon Wireless, which was a dominant player in the U.S. wireless services market at the time. came into existence in 1999 through a merger of Vodafone’s Airtouch and Bell Atlantic’s mobile division.

As a part of the acquisition, Verizon Communications took full control of Verizon Wireless from Vodafone, leading to the end of its 14-year stint in the U.S. telecom market. The deal resulted in windfall gains for Vodafone investors as they pocketed £54.3 billion.

4. Dow Chemical’s Acquisition of DuPont

In December 2015, the two chemical conglomerates—Dow Chemical and DuPont—announced their intention to merge in a deal valued at $130 billion. Completed in September 2017, the combined companies took on the name DowDuPont and included three divisions: agriculture, materials science, and specialty products.

However, the new conglomerate’s intention was never to remain as a single unit, but instead to restructure the entity by spinning itself off into separate companies. In 2019, DowDuPont broke up into three distinct companies:

• Dow (DOW), a commodity chemical company
• DuPont (DD), a specialty chemical maker
• Corteva (CTVA), an agricultural company that produces seeds and agricultural chemicals

5. Anheuser-Busch InBev’s Acquisition of SABMiller

The world’s largest brewer acquired its rival in a merger valued at approximately $104 billion in 2016. Anheuser-Busch InBev (BUD), which makes Corona, Budweiser, and Stella Artois, took over London-based SABMiller, the maker of brands including Fosters, Castle Lager, and Redd’s. 

One focus of the merger was to create a company that could effectively compete in emerging markets with strong growth potential. According to company management, Latin America and Africa offered the brewing conglomerate opportunities to expand into rapidly growing regions with increased revenue and market share. Emerging markets continue to remain a focus, where beer represents 1.6% of gross domestic product (GDP).

What’s the Difference Between an Acquisition and a Merger?

Acquisitions occur when one company purchases the assets and/or shares of another company. The acquiring company is usually bigger than the promising target. The acquirer normally makes an offer to the target, which can be accepted or rejected.

Mergers, on the other hand, involve two companies that agree to combine their operations into one. Once the merger is complete, both companies cease independent operations and, instead, operate as a new single unit.

Why Would a Company Want to Be Acquired?

Target companies may choose to be acquired for different reasons. Some of the primary reasons include gaining market share, acquiring new talent and resources, access to new markets, increased profitability, financial and tax benefits, and a shared culture with the acquirer.

How Is a Hostile Takeover Executed?

A hostile takeover happens when a target company rejects the offer to be acquired by another company. The acquirer may continue to pursue its target in one of several ways. This includes issuing a tender offer or an offer to the target’s shareholders, which the majority must accept, or purchasing a majority of the target’s stock on the open market.

The Bottom Line

Acquisitions are common in the corporate world. Most are executed during a bull run or in a particular sector with an expectation of success. But not all of them are successful. Some of the biggest disasters in M&A are attributable to multiple factors, including failures to culturally integrate both entities, overall economic conditions, and geopolitical issues. 

Reviewed by David Kindness
Fact checked by Suzanne Kvilhaug

Accounting vs. Economics: An Overview

Accounting is a profession that records, analyzes, and reports income and expenses for individuals and businesses. Economics is a branch of social sciences concerned with production, consumption, and market forces. An economist uses data to help shape policies for interest rates, tax laws, and employment.

Key Takeaways

• Accountants track the flow of money for businesses and individuals.
• Economists monitor trends that drive production and consumption.
• Accounting and economic data influence the fiscal policies of both businesses and governments.

Accounting

Most individuals deal with accountants when filing tax returns. In business, accountants track money into and out of an organization. They use various methods to record and analyze budgets, expenses, and revenue and produce financial records based on their data.

An accountant’s book is a historical record of an individual or organization’s financial life for a specific period. In the U.S., accounting standards, known as Generally Accepted Accounting Principles (GAAP), ensure a company’s financial statements are complete.

Publicly traded companies rely on accountants to file quarterly and annual financial reports required by the Securities and Exchange Commission (SEC).

Important

The 10-Q quarterly report and the 10-K annual report filed with the SEC provide transparent financial data to shareholders of publicly traded companies.

Economics

Economics focuses on how resources are allocated. Macroeconomics studies the distribution of resources within an ecosystem, such as a nation. It analyzes factors like the inflation or productivity rate that affect how efficiently the economy works. Microeconomics studies the behavior and decision-making of individuals and businesses within an economic ecosystem.

Economists compile data and analyze how goods and services are produced and distributed. Economists help develop economic policies for governments and project the impact of policy and regulatory changes. They may hold positions in government, academia, or the financial services industry, where they interpret and forecast market trends.

Note

Economists use statistics like Gross Domestic Product (GDP), the total value of goods and services produced within a country’s borders in a specific period, to measure an economy’s output.

Careers and Salaries

Both accountants and economists help businesses, industries, and governments to strategize and plan, make sound financial decisions, and set fiscal policies. Professionals in both fields base their analyses and projections on real-life markets, conditions, and events.

In 2024, over 1.5 million accountants and auditors were employed in the U.S. According to ZipRecruiter, salaries range between $53,500 to $78,500 with top earners making $95,000 annually.

An economist can work in multiple fields and positions, including banking, business consulting, financial services, government, public policy, or urban planning. In 2024, an individual with a master’s degree in economics earned an average of $156,100 as a financial manager, while a budget analyst earned an average of $84,940 annually.

What Are the Most Important Economic Indicators in the U.S.?

The U.S. Bureau of Economic Analysis compiles monthly, quarterly, and annual data to analyze the health of the U.S. economy. The principal indicators include Gross Domestic Product (GDP), personal income data, and international trade and its value for goods and services.

How Does Economic Data Affect Government Policy?

Data compiled by the BEA is used by entities such as the Council of Economic Advisers for briefing White House officials on U.S. economic conditions, the Federal Reserve Board to achieve maximum employment and price stability, and the Congressional Budget Office to project budgetary needs. 

What Is the Difference Between an Accountant and a CPA?

All Certified Public Accountants (CPAs) are accountants, but not all accountants are CPAs. Both may perform audits, provide financial advice, and complete tax returns. However, CPAs are licensed by a state board of accountancy, have passed the CPA exam, and have completed a specific amount of general accounting experience. To work in public accounting, professionals must earn their CPA license.

The Bottom Line

Accountants help individuals and businesses track and forecast their financial records. They may work in taxation, public accounting, or auditing. Economists compile and analyze data that influence fiscal policies. Those in government employment may work with an organization such as the Bureau of Economic Analysis to research employment or production data.

Even with no employer match, a 401(k) might be worth it

Fact checked by Ryan Eichler
Reviewed by David Kindness

One key advantage of a 401(k) plan is that employers often provide a matching contribution. Employer matches represent a guaranteed return on your retirement investment, and it almost always makes sense to maximize them.

If your employer doesn’t offer any match, you may be wondering if you should still participate. The short answer, in most cases, is that it does still make sense to contribute to a 401(k) because it can offer significant tax advantages. In this article, we’ll look at why participating in a 401(k) plan can make financial sense when there’s no employer match—and when it may not.

Key Takeaways

• Many 401(k) plans offer employer matching contributions, but some don’t. 
• Even without an employer match, you might want to participate in a 401(k) because of its tax advantages.
• Traditional 401(k) plans provide an up-front tax deduction plus tax deferral on your account’s earnings until you take the money out.
• Roth 401(k)s offer no immediate tax deduction, but your withdrawals can be tax-free if you meet the requirements.
• However, if your employer’s 401(k) plan has high fees or limited investment choices, you may want to invest your money elsewhere, such as in an individual retirement account (IRA).

When 401(k) Plans Without a Match Are Worthwhile

The employer matching contribution that is part of many 401(k) plans is an attractive benefit. In some cases, it is equivalent to your employer guaranteeing a 100% return on your investment. However, it’s not the only advantage that 401(k) plans have to offer.

With a traditional 401(k), your contributions to the plan are tax-deductible and the account’s earnings over the years will be tax-deferred. You won’t owe taxes on any of that money until you withdraw it, usually in retirement. If you contribute to a Roth 401(k), you won’t receive any up-front tax deduction, but all of your withdrawals will be tax-free if you meet certain rules.

These tax benefits are the same for every standard 401(k) plan, whether your employer makes a matching contribution or not. If you are going to be in a lower income tax bracket in retirement than you are now, as is often the case, then putting your money in a 401(k) could save you a significant amount of money in taxes.

Of course, there are other ways of saving for retirement besides a 401(k). A traditional individual retirement account (IRA) works much like a traditional 401(k) when it comes to taxation, and it might offer you a broader range of options for investing your money. And a Roth IRA works much like a Roth 401(k). However, IRAs have much lower annual contribution limits. Consider your options regarding the following contribution limits:

2023 and 2024 Common Retirement Account Contribution Limits
Retirement Account	2025 Contribution Limit	2024 Contribution Limit
IRA	$7,000	$7,000
IRA Catch-Up Contribution	$1,000	$1,000
401(k)	$23,500	$23,000
401(k) Catch-Up Contribution	$7,500	$7,500

When 401(k) Plans Without a Match Don’t Make Sense

While it generally makes sense to save for retirement through your 401(k) even if your employer won’t match your contributions, there are a couple of exceptions.

The first exception is if the 401(k) that your company offers is not ideal for you. Some 401(k) plans come with high fees. Others have extremely limited investment options. Others may also be incompetently run. However, even these less ideal plans might be worth participating in if they have a really good employer match. Still, if you value flexibility, lower fees, and more funds to choose from, 401(k) plans may not make sense in this situation.

The second exception is if you are not earning enough income. Saving for retirement takes money away from building an emergency fund, paying bills, and living life today. Saving for retirement is a luxury that many people simply can’t afford.

Last, you may choose to not contribute to a 401(k) if you don’t plan on staying with the company long-term. In this situation, especially if you don’t plan on contributing more than the IRA limit, you may be better off putting retirement funds into an IRA instead. You would receive similar tax benefits while avoiding the hassle of transferring the funds out of an old 401(k) when you leave the company.

Important

Even if your employer matches your 401(k) contributions, that money doesn’t belong to you until it has vested according to the rules of your plan. Many vesting schedules last several years.

What Is a Good Employer Match?

In a 2024 survey by Vanguard, the average value of employer-matching contributions was 4.6% of pay. The median—meaning half of plans were higher, and half were lower—was 4.0%. Most employers offered 3% to 6.99%. Seven percent of plans offered a 2% match, and 8% of plans offered a match that was 7% of pay or higher.

Can an Employer Stop Its 401(k) Match?

With a traditional 401(k) plan—the type typically offered at larger companies—the employer is free to change or even eliminate its match from year to year. However, SIMPLE (Savings Incentive Match Plan for Employees) 401(k) plans and safe harbor 401(k) plans—found most often in small businesses—must provide either an employer match or nonelective contributions. (Nonelective means the employer makes a contribution whether or not the employee contributes to the plan.)

How Does Vesting Work in a 401(k) Plan?

The money that you contribute to a 401(k) plan is immediately vested—meaning that it belongs to you from day one. However, depending on the terms of your plan, any contributions that your employer makes might not vest until a particular date (cliff vesting) or might vest little by little over time until you’re fully vested (graduated vesting).

When you check your 401(k) account, you will likely see your employer’s contributions even if they’re not fully vested. Should you leave the company before your vesting period has finished, you will forfeit all or a portion of the match.

For example, a company with a 5-year graduated vesting schedule releases 20% of its contributions to its employees each year. Should an employee leave after three years, they will only receive 60% of their employer’s contributions to their account.

The Bottom Line

Many, but not all, 401(k) plans offer employer matching contributions. Even if your employer doesn’t provide a match, you may want to participate in the plan because of its tax advantages. An exception might be if your 401(k) plan has unusually high fees or poor investment choices, or if you believe it to be badly run.

3 tips from a financial advisor

Over the past two years, several of my clients have been laid off. Industries like the tech sector have been tough for various reasons, including AI advancements and staff reductions from the post-pandemic hiring surge. 

During an uncertain job market, it’s important to ensure you have a financial cushion and plan in place in case you lose a job. Bonuses—or a windfall like a tax refund—are a great opportunity to boost these efforts.

Key Takeaways

• Bonuses provide a unique chance to prepare for potential job loss or prolonged job search, especially in industries facing uncertainty like tech.
• One of the best uses for a bonus is to reduce or eliminate high-interest debt, like credit card balances or personal loans. This can ease financial strain if income becomes limited.
• Bonuses can be a helpful tool for covering recurring or large future expenses, such as insurance premiums or planned vacations.

What I’m Telling My Clients

According to a recent Wall Street Journal report, the number of people in the U.S. who have been job hunting for at least six months is up more than 50% since late 2022. Workers earning six figures struggle to find new jobs after being laid off, and the job search is taking longer. 

For clients who do have their job and receive a bonus, this extra income is a great opportunity to safeguard finances against a potential job loss. Here are some steps clients can take to use their bonuses towards this preparation:

1. Boost Your Emergency Fund

If a client works for a company offering a standard severance package, I recommend they have at least twelve months of living expenses between their emergency fund and the anticipated severance. Saving at least half a bonus towards this fund can help clients achieve this goal faster.

2. Manage Debt

A bonus allows one to reduce or eliminate debt obligations. If a client has high-interest debt, like credit cards or personal loans, I prioritize paying those off and encourage them to avoid new debt commitments. These actions help clients manage their fixed expenses, which are harder to adjust during challenging times when income is limited.

Warning

The average credit card balance for U.S. consumers was $6,730 in Q3 2024, a 3.5% increase from the previous year.

3. Plan for Future Expenses

Consider what new expenses or purchases may come up over the next year. Clients often have recurring annual costs (such as property taxes or insurance payments) or a large planned expense (like an anniversary trip). These can be funded with monthly savings or in a lump sum with bonus proceeds.

That way, if something like a job loss were to happen, clients would already have a roadmap in place, so they don’t have to worry down the line.

The Bottom Line

A bonus is undoubtedly an exciting achievement and income boost. While it may be tempting to splurge on something fun, it’s important to be ready for the unexpected. By using a bonus to prepare for uncertain times, such as boosting your emergency fund, managing your debt, and planning for future expenses, clients can rest easy knowing they have a financial cushion in place amidst an unpredictable job market.