When your 401k loses money – whether it’s due to market turbulence or fees – it’s important to understand what’s happening. Then you’ve got two choices: do something, or do nothing.
Market Turmoil
The most dramatic losses in 401k plans come from market losses: the things you buy lose value (or “go down”), and your account balance decreases. So how should you react when markets go crazy?
First, it’s essential think about your long-term goals. If you don’t have long-term goals, that’s a problem (a much bigger problem than what the market is doing this week). Get a basic idea of where you stand and where you’re headed and then come back to this page. Without a big-picture view, you’re driving around without a map. Entering trades in your account can wait.
When do you plan to use the money in your 401k – in a few years, or more like 10 years? How much do you need to earn to reach those goals?
Now, look at your current investments in the 401k. Are they mostly in riskier holdings like stocks, or “safer” (but not necessarily risk-free) holdings like bonds and cash. If you’ve suffered major losses, there’s a good chance you hold some stock. You might also use some type of asset-allocation fund, which is perfectly fine, and it may take a bit more digging to understand how risky those funds are.
For more detail, see What to Look for when you Review your 401k. For now, you’re still evaluating the situation, and action might or might not be necessary.
Red on the Screen
At this point, you may notice that we haven’t addressed what the market is doing RIGHT NOW. There’s a reason for that. What’s done is done, and what’s happening right now is probably irrelevant to your long-term goals (remember those? Your golden years, where you get to [fill in the blank] all day long). Just because the market went down yesterday, or all last week, or all last month, it doesn’t mean it will go down forever. Want proof? Try this game (it’ll take maybe 5 minutes or less while you try to time the market).
It might feel like you need to do something dramatic right now, but that’s often a mistake. There’s nothing wrong with those feelings – it stinks to lose money and your emotions are telling you that something stinks. Now your job is to evaluate the situation and take the best route forward.
The financial media is also to blame for making you feel like you need to do something rash. But the market goes down at some point every single year (yet over long periods of time – so far – it has generally gone up). It isn’t news, it’s just the way it works. But they’ve gotta keep it exciting so they can sell ads… Even when the market goes up, you’ll hear that it might be too high to invest.
In some situations, it makes sense to say “don’t just stand there – do something!” But when you’re losing money in a market correction, it might be better to say “don’t just do something – stand there.” Making decisions and changes in reaction to day-by-day events is not a good strategy.
Your Goal, Your Choices
Back to your goal: spending that money to buy stuff in retirement. You need to build up a nest egg that can support your spending in retirement. Generally, the more risk you can tolerate (without getting too crazy… we’re talking about typical 401k options here – a stock heavy asset allocation fund or a bunch of index funds invested in stocks), the greater your returns will be over the long term. But you have to put up with, accept, and not react to market risk.
The alternative is to invest conservatively in your 401k. You’ll see much less fluctuation, and you won’t have to worry when the market crashes. To do so, you might look at the money market fund, fixed account, or high-quality short-term bond funds. But there’s always a tradeoff: over long periods of time (decades or more) you risk losing purchasing power to inflation. In other words, you risk not reaching your goals.
If you invest conservatively, that’s fine, but you’ll have to contribute a lot more to your account to reach your goals. For most people, the amount required is simply out of reach. For example, assume you wanted to retire with one million dollars (which ain’t what it used to be) in 25 years. You’d have to contribute $2,403/month to your account if you earn 2.5%/year in conservative investments. Alternatively, if you earned 7.5%/year by taking more risk (and yes, you would lose money some years), you might only need to contribute $1,140/month to reach the same milestone.
So if you want to be conservative in the example above and you don’t have $2,403/month, you’re going to come up short and you’ll have to change something.
Are you Properly Invested?
With your big picture goals in mind, look at your account. Are you properly invested, or does something need to change?
If you’re willing and able to take market risk (with the hope of better long-term returns), then this type of loss is normal. As long as you’ve done a good job setting up your investments (you’re well diversified and using the proper types of investments) then you’d need a good reason to change. Perhaps that reason is you’ve decided you’d rather risk missing the goal due to inflation – it’s up to you.
Or maybe the big picture view tells you that you’re doing the right things, but the current environment is unpleasant. Will things ever improve? In your lifetime? In the next 10 years? Maybe this too shall pass. I wouldn’t bet against the world, but it’s up to you.
If you’re not willing and able to take market risk, you’re in a tough spot. There’s nothing you can do about the past, so pick the best approach going forward. You might one or two years away from (or into) your retirement, which is a bad time to take huge losses. So it might be prudent to at least protect several years’ worth of spending money (create a ‘bucket’ of safe money that you can spend from and ignore the markets). The middle of a market correction might not be the best time to do that, but you never know – things could always get worse over the next year or two.
Even if you’re into your golden years, it might not make sense to completely get out of stocks. Inflation will continue to cause price increases, and some portion of your portfolio should probably be invested in a way that helps combat that effect.
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