When the stock market is down and your investments are too, it’s easy to wonder, “What is the stock market doing to my 401k?” The answer, however, is it’s helping it. Even if it isn’t right at this particular moment or next month’s moment, it’s very important to remember that, on balance, the stock market helps your 401k — a lot. If there’s one thing you should remember about the relationship between your retirement account and the stock market, that’s it. Why? Because at times — like the last few months, for instance — falling markets and doomsday headlines will prompt a lot of casual investors to fall into a cycle of repeatedly checking in on their balance and wondering why those dastardly stocks are ruining their dreams of living out their golden years on a beach in Bali. Or worse, it causes investors to move their money.
But this would be a clear example of “missing the forest for the trees.” Sure, there will be brief periods of time where the stock market will fall and your 401k will experience a painful loss of value. But those moments are when it’s most important to keep coming back to that same mantra: “The stock market helps my 401k.” Overreacting in those brief periods is one of the worst things you can do to your retirement plans in the long run.
Without the Stock Market, Your 401k Would Be in a Coma
Getting overly concerned about your 401k in falling markets is like getting really concerned about food because you have indigestion. Food might be causing you pain right at that moment, but if that leads you to conclude that food is bad for you, well, you probably have some much bigger issues than your 401k.
Without food, you will die. Seriously, just ask your doctor. And although dying would technically mean your indigestion would be gone, most people would probably agree that the occasional bout of heartburn is worth it for, you know, life. Pulling your money out of stocks wouldn’t exactly kill your 401k, but it would at least put it in a coma.
The S&P 500 has averaged a nearly 10 percent annual return over its history. Over the course of 30 years, a 10 percent interest rate would turn $10,000 into about $174,500. Not necessarily a beach in Bali but still pretty good. That same amount in a savings account earning 1 percent — which is easy to find but far higher than the 0.09 percent national average interest rate at present — would leave you with a little less than $13,500. A high-yield savings account earning you 2 percent interest takes you all the way up to a little over $18,000 over the same period of time. And if you stick to AAA-rated corporate bonds that have yielded about 4 percent in recent years? That would translate to around $32,400. Not bad, but less than a fifth of the returns for investing in stocks.
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When Stocks Fall, They Usually Bounce Back Quickly
Granted, the above example isn’t entirely fair. That 10 percent a year is not a consistent, year-in-year-out sort of thing. If the market plunges 30 percent halfway through year 30 — as it has been known to do — it changes that overall return considerably. But overreacting to those dips is a big mistake, no matter what the headlines are blaring at you about crashing markets.
Here’s a fun exercise to help you weather the storm when you’re feeling anxious about your 401k: Any time you see an article about how markets are in turmoil, note the date. Then, keep checking back in on the market every day after that and note just how long it takes until the Dow Jones Industrial Average or S&P 500 gets back to where it was prior to the dip. More often than not, things will be back where they started inside of a couple of weeks, maybe a month.
What you’ll also start to notice is that part of your concern is just a function of the way the news media covers stocks. A one-day drop of 300 points from the Dow is a gripping, click-worthy headline. The Dow gaining back those 300 points a little bit at a time over the next week and a half is not. But, in terms of your 401k, the gradual, not-newsworthy recovery is equally as important as the dramatic one-day drop.
Even when you’re talking about something larger than a single-day hiccup — say the massive drop in 2008 caused by the housing crash — the recovery time is still much shorter than you might assume. If you had all your money in an S&P 500 fund when the housing crash hit, you would have recovered all of your losses within six years. And if you kept holding on, you would have been up 25 percent after about seven years. Not too shabby for the biggest financial disaster since the Great Depression. And that situation was significantly worse than usual. A market correction — which is defined as a drop of 10 percent or more — lasts about four months on average and takes about the same length of time to recover, while a bear market — a drop of 20 percent or more — lasts a little over a year and takes about two years to recover, on average.
Asset Allocation Can Protect You as You Approach Retirement
Now, there is one rather important caveat to this: people who are nearing or just entering retirement. If your plans called for 2018 to be your last year in the workforce, that dip at the end of last year was more than just a hiccup — it could mean your portfolio is seriously hampered right when you need it the most. And if you were planning to retire midway through 2008? Well, that roughly six-year wait until your 401k recovered was a lot bigger than a minor inconvenience.
That’s why one of the general rules of thumb you hear about investing is to gradually shift your money from stocks, with all of their ups and downs, to bonds, which, if you hold them until maturity, provide a very stable and predictable — if smaller — return. And, as you approach retirement, that stability becomes more important than just getting the most out of your 401k because you can no longer just wait out market downturns until they bounce back.
But you shouldn’t have too much trouble getting help with rebalancing your portfolio as you age. Not only will any financial advisor worth their salt know how to handle this in their sleep, but most 401k companies or brokerages will offer primers on how to approach this and help you along the way. Even if you don’t have someone helping you, there are plenty of sites that will provide calculators to help you determine the right mix for your age.
And if all else fails, the age-old rule of thumb is that the percentage of your portfolio that’s in stocks should be about 100 minus your age, so 40 percent for a 60-year-old, 30 percent for a 70-year-old and so on. It’s not necessarily an ideal approach for everyone, but it’s still a simple formula that’s easy to follow.
Take a Deep Breath and Remember: ‘The Stock Market Helps My 401k’
So, before you start to worry about what’s happening to your 401k, take a deep breath and remember that the stock market is what fuels your retirement account. Any money that you’re “losing” from your retirement funds likely wouldn’t exist in the first place without that same stock market. Even if it might look pretty grim at times, the long-term view of the stock market has been remarkably consistent once you smooth out the spikes and plunges along the way.
Stocks, like food, aren’t going to work out perfectly 100 percent of the time. There’s going to be that afternoon at the county fair where the combination of chili dogs, funnel cake and deep-fried Oreos leaves you wishing you didn’t have a mouth. But you just can’t get by without food. After all, even heartburn can’t ruin a beach in Bali.
Click through to read more about the things you should never do with your 401k.
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