How to protect your 401(k) in a bear market

Editor’s note: This is an updated version of a story published on August 29, 2022.

Stocks and bonds trade in bearish territory. And given the current circumstances, it’s fair to assume the markets will stay volatile for a while.

Interest rates are rising rapidly in the US and Europe amid government efforts to curb rampant inflation. Fears of recession remain. The sharp depreciation of the British pound and the increase in the UK’s debt costs are a cause for concern.

After experiencing congestion in the first half of 2022 return some With the S&P 500 down more than 20% year to date, stocks are back in the red for the year. The S&P US aggregate bond index fell by about 14%.

And investors can see more losses over the next year.

“As the Federal Reserve continues to raise interest rates to fight inflation, markets will be volatile — both up and down — over the next six to 12 months,” said Chris Zaccarelli, chief investment officer at the Alliance of Independent Advisors. “If you’re planning to buy stocks at this point, you’re going to have to be patient and hold those positions longer than most people are used to — potentially two to three years in some cases.”

While it’s a tough road ahead, there are some ways to mitigate the potential damage to your long-term nest egg.

Bear markets can be bearish to your psyche. You may want to sell your equity investments and move the proceeds into cash or a money market fund.

You’ll tell yourself that when things improve, you’ll move the money back into stocks. But doing so will only cover your losses.

If you’re a long-term investor—including those in their 60s and early 70s who may have been retired for 20 or more years—don’t expect to outpace current downtrends.

As for investing success, “It’s not about timing the market. It’s time in the market,” said Taylor Wilson, a Certified Financial Planner and president of Greenstone Wealth Management in Forest City, Iowa. “During bull markets, people think the good times will never end, and in bear markets, they think things will never be good again. Focusing on what you can control and implementing proven strategies will pay off over time.”

Let’s say you invested $10,000 in the S&P 500 in early 1981. That money would grow to about $1.1 million by March 31, 2021, according to Fidelity Management & Research. But if you missed just the five best trading days over those 40 years, it would only add up to about $676,000. If you had sat for the best 30 days, your $10,000 would have only grown to $177,000.

If you can convince yourself not to sell at a loss, you may still be tempted to hold off on making regular contributions to your retirement savings plan for a while, thinking you’re throwing good money after bad.

“It’s a difficult thing for a lot of people because the knee-jerk reaction is to stop contributing until the market recovers,” said Sefa Mawuli, CFP of Pavlov Financial Planning in Arlington, Virginia.

“But the key to 401(k) success is consistent and ongoing contributions. “Continuing to contribute during down markets allows investors to buy assets at a lower price, which can help your account recover faster after a market downturn.”

If you can afford it financially, Wilson recommends increasing your contributions, even if you haven’t reached the maximum. Along with the value of buying more at a discount, she said, taking a positive step can take the anxiety out of watching your nest egg (temporarily) shrink.

Life happens. Plans change. And so it may be time to retire. So, check whether your current allocation to stocks and bonds matches your risk tolerance and ideal retirement date.

Wilson, do this even if you are in a target date fund. Target-date funds are designed for people who will retire in a certain year — say 2035 or 2040. As that target date approaches, the fund’s allocation will become more conservative. But if you’re someone who started saving late and needs to take on more risk to meet your retirement goals, he noted, your current target-date fund may not offer that.

Mark Struthers, a CFP at Sona Wealth Advisors in Minneapolis, works with 401(k) participants at organizations that hire his firm to provide financial wellness advice.

So he heard from people across the spectrum expressing concern that they “can’t afford to lose” what they have. He said even many educated investors wanted out during the recession at the start of the pandemic.

Struthers will advise them not to panic and remember that drawdowns are the price investors pay for the big returns they get during bull markets. But he knows that fear can overcome people. “You can’t just say ‘don’t sell,’ because you’re going to lose some people and they’re going to be worse off.”

Investors were particularly disheartened to see bonds, which should reduce the overall risk of their portfolio, also fall. “People are losing faith” Struthers said.

So instead of trying to go against their fears, he’ll try to get them to do something to relieve their short-term anxiety, but with the least long-term damage to their nest eggs.

For example, someone may be afraid to take enough risk in their 401(k) investments, especially in a falling market, because they fear losing more and having fewer financial resources if they ever get laid off.

So he reminds them of available rainy-day assets like an emergency fund and disability insurance. He can then suggest that they continue to take enough risk to generate the growth they need in their 401(k) for retirement, but redirect some of their new contributions to a cash equivalent or lower-risk investment. Or, he might suggest rolling the money into a Roth IRA, because those contributions can be accessed without tax or penalty if needed. But it’s also about keeping money in a retirement account when a person doesn’t need it for an emergency.

“Just knowing they have the comfort money there helps them panic,” Struthers said.

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