In the face of a bear market, it’s crucial to remember not to panic. As share prices rise during a bull market, it’s easy to forget that the good times won’t last forever. When the bear market hits, your retirement goals may seem further away, but there are steps you can take to protect your 401(k) plan.
Crafting a solid investment plan is key to reaching your retirement goals. Ensure your 401(k) investments are diversified across asset classes to minimize risk. When markets fall, resist the urge to sell in panic. Instead, consider buying at discount prices. Avoid making 401(k) withdrawals early, as this will incur taxes and a 10% penalty. If you’re closer to retirement, it’s wise to shift your 401(k) allocations to more conservative assets like bonds and money market funds.
Having a strategy is crucial, especially during a market losing streak. If you don’t know how much money you need to achieve your retirement goals, you won’t be able to accurately assess the damage when the markets take a tumble. Investing isn’t about picking a hot stock or mutual fund and riding it to the moon. Focus on setting a realistic goal and tailoring your investing strategy to reach it.
After determining how much money you’ll need, the next step is to figure out how your investments can help you get there. Asset allocation is key. Your money should be diversified between stocks and bonds to help you ride out market storms. The allocations will vary with factors like your age and risk tolerance. Younger savers have more time to recoup bear market losses, and so may benefit less from the advantages of bonds in lowering the risk and volatility of a retirement portfolio.
Diversification is particularly important if your employer’s stock makes up a large portion of your retirement portfolio. If the stock market is in trouble, having too many eggs in one basket could scramble your returns. Limiting employer stock to no more than 10% of your holdings is a good rule of thumb.
Studies have shown that modest portfolio adjustments during a bear market, such as increasing an allocation to stocks from 50% to 60%, resulted in minimal improvement to returns. In fact, 98% of the 401(k) accounts surveyed made no plan changes in March 2020 as the S&P 500 plunged as much as 34% from the prior month’s highs.
In times of market stress, the urge to sell everything can be overpowering. However, stocks have recovered from every bear market in the modern era. There is a strong probability your paper losses will eventually be erased by subsequent market gains—unless you lock them in by selling at the lows.
If you had a long-term investment strategy in place before the markets took a dive, it’s time to revisit your plan. Are your goals still the same? Is your retirement still years in the future? If the particulars of your situation haven’t changed, this is no time to change your overall investment strategy.
Remember, if you take withdrawals from your 401(k) account while under age 59½, you will be hit with a 10% penalty on top of income tax on the withdrawn amount. Withdrawing from a tax-deferred savings vehicle like the 401(k) when you’re not required to do so also gives up a valuable tax benefit, since 401(k) plans defer capital gains taxes. The combination of the tax liability, the 10% penalty, and forfeited future tax savings can be toxic for your retirement goals, and that’s before considering the risk of selling at or near market lows and missing out on the rebound.
When the markets drop, lots of people want to sell and get out. That’s an emotional impulse driven by fear. Consider instead that reduced share prices might amount to a sale. Don’t reduce your 401(k) contributions, or the allocation of new savings to stocks, just because the stock market is struggling at the moment.
In fact, a bear market is often the right time to increase the percentage of income you contribute to your 401(k) if you can afford to do so. If your employer offers a matching contribution, raise your contribution at least to the level of the maximum match. Securing the largest possible employer match is the easiest, least risky investment you will ever make, and will help your plan recoup its bear market losses that much faster.
Over the long term, the stock market has generally gone up. Use that trend to your advantage. If you are invested in stocks, those holdings will likely see their value fall. But, if you have several years until you need your retirement account money, keep contributing as you may be able to buy many stocks “on sale.” Most 401(k) plans have a restricted set of allowed investments, so you likely won’t be able to sell short or buy inverse ETFs. Instead, you may want to shift some stock holdings into bonds or money market funds if you are closer to retirement.
In a down market, you could transfer all of your holdings to cash or money market funds, that are safe but provide little to no return. This, however, is not often advised (unless you are already nearing retirement). Most retirement savers should continue to contribute to their plan and stick to their strategic asset allocation, since buying the dips should allow the portfolio to grow even larger over the long run.
Should you cash out your 401(k) if the market crashes? No. If you cash out your 401(k) plan you will have to pay the deferred income tax liability on all of the contributions and gains in the account at that time. Moreover, if you are under age 59.5, you will be hit with a 10% early withdrawal penalty, making it an even less attractive option. Instead, it is recommended to keep investing as the market dips and stick with your strategic plan.
Stock markets and economic cycles go through a rough patch every now and then. Don’t let the volatility make you forget that stocks tend to rise over time as listed companies earn returns on invested capital. This longer-term historical trend is your friend; use it to your advantage. Invest when assets are on sale and their owners are panicking. Stay rational and level-headed. Even the worst economic crises eventually give way to a recovery.
If you’re young enough, you likely have decades of saving and investing ahead. Raiding your retirement fund early or shunning stocks during bear markets has huge long-term costs. Stay the course, if you can.
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