401(k)

    Safeguarding Your 401(k) Against Stock Market Crashes

    Mastering Your 401(k) for Long-Term Financial Security

    Table of Contents

    401(k): Introduction

    In the realm of investment, particularly concerning your 401(k) and retirement savings, it is vital to recognize that the stock market cannot maintain perpetual upward growth. Periodic corrections, characterized by stock declines of 10% or more from recent peaks, occur every few years and can persist for several months. Although less frequent, stock market crashes can be sudden and severe, as exemplified by the 2008 financial crisis and the 2020 crash triggered by the coronavirus pandemic. The years 2022 and 2023 have further accentuated market uncertainty. However, with proactive measures, it is possible to prepare for market volatility and protect your valuable retirement savings. Consulting with a financial advisor can be instrumental in navigating these fluctuations and securing the stability of your 401(k) and other investments.

    401(k):Mitigating Risk

    Any time you put your money in the stock market or other investments, you always run the risk of losses. While you can make largely educated decisions, things don’t always go to plan. Also, because you’re talking about something as important as your retirement, emotional decision-making can come into play.

    Despite the above, there are many strategies, simple and complex, you can use to mitigate risk. For instance, spreading your assets across multiple types of investments and areas of the market can allow you to avoid the volatility that comes with stock-picking and concentrated investment positions.

    Everyone has short-term expenses that periodically arise. For example, you might need to repair your car, replace a broken household appliance, or pay for a medical procedure. Long-term expenses are even more prevalent, including student loans and mortgages. However, the best thing you can do is treat your retirement savings just as important as all of your other needs. This will ensure your pool of retirement funds will continue to grow over time.

    Don’t Panic and Withdraw Your Money Too Early

    Surrendering to the fear and panic that a market crash elicits can cost you. Withdrawing money early from a 401(k) can result in hefty IRS tax penalties, which won’t do you any favors in the long run. It’s especially important for younger workers to ride out the market lows and reap the rewards of the future recovery.

    DiversificationDiversify Your Portfolio

    Finding the right asset allocation is crucial to protecting your 401(k) from a stock market crash, while also maximizing returns. As an investor, you understand that stocks are inherently risky, and as a result, offer higher rewards than other assets. Bonds, on the other hand, are safer investments but usually produce lesser returns.

    Having a diversified 401(k) of mutual funds that invest in stocks, bonds, and even cash can help protect your retirement savings in the event of an economic downturn. How much you choose to allocate to different investments depends in part on how close you are to retirement. The further you are from retiring, the more time you have to recover from market downturns and full-fledged crashes.

    Therefore, workers in their 20s would likely want a portfolio more heavily weighted in stocks. While other coworkers nearing retirement age would probably have a more even distribution between lower-risk stocks and bonds to limit exposure to a market drop.

    But how much of your portfolio should be invested in stocks vs. bonds? A general rule of thumb is to subtract your age from 110. The result is the percentage of your retirement portfolio that should be invested in stocks. Investors who are more risk-tolerant can subtract their age from 120, while those who are more risk-averse can do the same from 100.

    However, the above rule of thumb is fairly basic and limiting, as it doesn’t allow you to account for any of the specifics of your personal situation. A more comprehensive approach would be to build an asset allocation that includes your goals, risk tolerance, time horizon, and more. While you can technically create your own portfolio allocation plan, financial advisors typically specialize in it.

    Rebalance Your Portfolio

    Rebalancing your portfolio, or changing how much you have in different assets, is another vital component of protecting retirement savings from crashes. The idea is that over time, some investments may fare better than others, changing the percentage of money in each asset and potentially exposing you to more risk. By rebalancing, you bring the percentage of money invested in stocks and bonds back in line with your original investing target from the section above.

    The easiest way to ensure your 401(k) is continually rebalanced is to invest in a target-date fund, a collection of investments designed to mature at a certain time. Target-date funds automatically rebalance their investments, moving to safer assets as the target date approaches.

    But if you pick your own 401(k) investments, you’ll want to rebalance your portfolio at least once a year. Some financial advisors may recommend rebalancing as often as once a quarter. You can do this by selling off positions with gains that have tipped your portfolio out of balance. This is especially important for investors who are nearing retirement. It’s also worth noting that rebalancing isn’t the same as withdrawing money. These transactions are happening within your 401(k) and won’t immediately result in taxes.

    Keep Some Cash on Hand

    Some financial professionals recommend retirees have enough cash or cash equivalents to cover three to five years’ worth of living expenses. Having cash reserves can help pay for unexpected expenditures that a fixed income may not otherwise be able to cover.

    Cash on hand can also mitigate what’s called “sequence of returns risk.” That’s the potential danger of withdrawing money early in retirement during market downturns and, thus, permanently diminishing the longevity of a retirement portfolio. By selling low, the longevity of the investor’s portfolio is jeopardized. However, with cash reserves, retirees can withdraw less money from their 401(k) during a market decline and use the cash to cover living expenses.

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    Continue Contributing to Your 401(k) and Other Retirement Accounts

    Steadily contributing to your 401(k) is another way to protect it from future market volatility. Cutting back on your contributions during a downturn may cost you the opportunity to invest in assets at discount prices. Meanwhile, maintaining your 401(k) contributions during a period of growth when your investments have exceeded expectations is equally important. The temptation to scale back your contributions may creep in. However, staying the course can bolster your retirement savings and help you weather future volatility.

    How to Respond to a Recession

    Despite a perception that recessions and stock market slumps are always related, they are distinct and call for distinct responses from investors. Here are several guidelines for responding to a recession.

    Seek Out Core Sector Stocks

    During a recession, you might be inclined to give up on stocks, but experts say it’s best not to flee equities completely. Consider investing in the healthcare, utilities, and consumer goods sectors. People are still going to spend money on medical care, household items, electricity, and food, regardless of the state of the economy. As a result, these stocks tend to do well during busts (and underperform during booms).

    Focus on Reliable Dividend Stocks

    Investing in dividend stocks can be a great way to generate passive income. When you’re comparing dividend stocks, some experts say it’s a good idea to look for companies with low debt-to-equity ratios and strong balance sheets. If you don’t know where to start, you may want to look into dividend aristocrats. These are companies that have increased their dividend payouts for at least 25 consecutive years.

    Consider Real Estate

    The 2008 housing market collapse was a nightmare for homeowners. However, it turned out to be a boon for some real estate investors. When a recession hits and home values drop, it may be a buying opportunity for investment properties. If you can rent out a property to a reliable tenant, you’ll have a steady stream of income while you ride out the recession. Once real estate values start to rise again, you can sell at a profit.

    Precious Metal Investments

    Precious metals, like gold or silver, tend to perform well during market slowdowns. But since the demand for these kinds of commodities often increases during recessions or when recessions are expected, their prices usually go up, too. For example, when the Federal Reserve raised interest rates in March 2023, after the collapse of Silicon Valley Bank and Signature Bank, the price of gold and silver popped 1.54% and 2.79%, respectively.

    Conclusion

    Protecting your retirement savings from a stock market crash requires you to pay special attention. Keep a close eye on your asset allocation and investment variety, and rebalance when needed. Continuing to contribute to your 401(k) through both bull and bear markets can bolster your retirement savings for the future, while remaining calm during times of volatility will keep you positioned to capitalize on the eventual recovery.