6 Ways To Protect Your 401(k) From a Stock Market Crash
If you’ve been contributing to a 401(k) plan over the last several years, you’ve probably seen some pretty nice gains. At least until the beginning of 2022, when the stock market has really taken a dive. Since most 401(k) plans invest assets in mutual funds, stocks and bonds, you’ve probably seen your retirement savings dwindle, too. What’s an investor to do?
How Do I Protect My 401(k) During a Market Crash?
The best way to protect yourself and your retirement savings in the event of a crash will depend on a few factors, including how much risk you’re willing to take and how long you have until you plan to retire. But no matter what your situation is, the very first thing you should do is not panic. The market goes up and down — that is its nature.
Next, consider your specific situation and your best response. Here are some steps to take.
6 Steps to Protect Your 401(k)
Understand the Market Situation
The first step is to understand what will happen to your 401(k) if the stock market crashes.
While it’s disheartening to see your account balance decline, the nature of the stock market is that it rises and falls. The general trajectory over time is upward, but it’s certainly not a straight line. The market has declined before — sometimes steeply — and it will decline again. But it will also rise again.
Review Your Specific Situation
In a down market, it’s important to keep your eyes on the prize, the prize, in this case, being a comfortable retirement. Take a look at your goals, which will tell you how much money you will need to retire. If you don’t know this already, it’s a good time to crunch some numbers and try to figure it out. Then you can adjust your strategy to make it more likely that you will achieve those goals.
Consider how much you have saved already and how much you will save between now and retirement. Then figure in your expected rate of return, which will depend on how your assets are invested. Finally, factor in what you expect to spend during retirement, and see if you need to make adjustments in order to get to where you want to be.
Look at Your Asset Allocation
Whenever there is a downturn in the market, certain types of investments do better than others. Unfortunately, it’s not the same type of investment in every downturn, so it’s difficult to predict where to put your money to protect it.
The solution is to be sure that your portfolio is diversified amount different types of assets and different asset classes. So, you should have both stocks and bonds, and your stock positions should include small-, mid-, and large-cap stocks, as well as growth and value stocks.
The percentage of your assets that are allocated to each type will depend on your risk tolerance and the number of years you have until retirement. Younger investors can take more risk because they have more time to make up for any losses, but no one should take so much risk that they can’t sleep at night.
Many 401(k) accounts are invested in target-date funds. These are mutual funds that are designed to allocate your assets based on your projected retirement date. The mix of assets in these funds will change as you get closer to retirement, moving money out of riskier investments and into less risky positions as time goes on.
When you look at your account balance and see it decline, the temptation is to stop “throwing good money after bad,” as the old adage goes. But stopping your contributions in a down market is the wrong way to go.
Think about it this way: stocks are “on sale” compared to where they were last year. You’re buying shares of the same investment at a lower price than you were last year. Eventually, the market will turn bullish again, and prices will rise.
If you’ve been thinking about increasing your contributions, now would be a good time to do so. Again, you’ll be buying at a lower price, and those shares will have more room to grow. And you should always contribute at least enough to get your company match if there is one. If you’re not getting the full match, you’re passing on free money, and free money is always a good investment.
Stay the Course
You may be wondering what the safest place is to put your 401(k) or if you should move your 401(k) to safer investments. The safest place to put your money is in cash, but the return you will get is negligible and certainly won’t keep pace with inflation, which means you’d be losing purchasing power. So, unless you are just about to retire, this is probably not the best strategy.
In addition to the poor return, the other issue with moving to cash is timing. If you sell your investments and hold cash in your 401(k) to ride out the down market, when do you get back in? Just as you couldn’t have seen the downturn coming, you also won’t see the upswing begin until it’s in the rear-view mirror. By that time, you may miss out on some big gains.
For most investors, leaving your 401(k) assets invested is the best strategy, even in a downturn.
Don’t Cash Out
The temptation to cash out your 401(k) when the market is down can be strong, but there are good reasons not to do this. First, cashing out when the market is down just locks in your losses.
Plus, you will have to pay income taxes on any withdrawals — and not just on the gain, if there is any. The money you invested is taxed at regular income tax rates when you withdraw it. Plus, if you’re under 59½, you’ll pay a 10% early withdrawal penalty on top of the taxes.
The bottom line is that market fluctuations are a fact of life. In fact, they are what make investing worthwhile. And even though it can be difficult to see your account balance decline, try to focus on the fact that it will, if history is any guide, go back up again someday.
The result of every market downturn in history has been a subsequently higher market. The savviest investors know to stay the course and wait it out.