Today we shall look at how to protect your 401k from a market crash. I am certain that you agree with me that having enough money put aside for one’s retirement years is a goal worth having. Many people have taken to 401(k), which are to a great extent good retirement savings and retirement tools. 401(k)s are however prone to poor returns resulting from market crashes, which is why we shall figure out how exactly you can protect your hard-earned money from disappearing into the thin air.
Volatility in the market
Market volatility, even in the most seemingly stable industries, is inevitable. Most investors are already aware of the corrections that happen in the market every one to two years, in which the stock prices decline by about 10%. These declines can last for a couple of months at a time.
Market crashes, which are rarer than market corrections, happen abruptly and are more severe. Take for instance the 2008 financial crisis, or the 2020 crash that was triggered by the occurrence of the coronavirus pandemic. As we progress deeper into this year, you can actually tell that there is a lot of uncertainty in the market. I mean, what do you expect when a single tweet by the right or wrong person is capable of damaging your stock portfolio within hours?
Preparing for more severe market volatility, and worse market crashes is a prudent thing to do. Read on to find out more about what other professional investors are doing to shore up their assets from unpredictable events in the market.
What it means to protect your 401(k) from a stock market crash
Any time you decide to invest in stocks or other investments, you risk making losses. While it is possible to make educated guesses that lead to profitability, things will not always go your way. The one thing, however, that you should know is that when it comes to investing for your retirement you cannot afford to make emotional decisions. Making investment decisions based solely on how you feel may only lead to greater uncertainty and the maximization of the potential to make losses.
The good news, however, is that there are many strategies that you can apply to mitigate risks. Some of the strategies are simple, while others are quite complex. The approach you take is dependent on a number of factors, though it all boils down to how badly you want to shelter yourself from seeing those negative figures on your portfolio balances.
Spreading your assets across several investments in different industries in the market is actually a sound approach to avoid the volatility that comes with having your stocks concentrated in one industry.
Besides that, it is good to treat your retirement investment account with the utmost respect. What I mean by this is that you should avoid touching the funds in this account, unless you do not have other alternatives to fix the financial problem at hand. Unexpected expenses arise, and quite understandably so, but you do not need to turn to your emergency account every time you need some money to fix urgent problems. Most financial advisors will advise you to create an emergency account that takes care of such unforeseen issues. Doing this ensures that you have an ever-growing pool of retirement funds that can be restructured to include many more investment choices as time goes by.
1. Diversification & prudent asset allocation
One of the key factors to consider as you start investing for your retirement years is how you will allocate your funds to various assets. As an investor, you should understand that stocks are quite risky, hence are more likely to offer higher rewards than other assets. Bonds are, on the other hand, safer investments, but also have lesser returns.
You can aim at having a diversified 401(k) of mutual funds that comprise stocks, bonds, as well as cash, in order to protect the funds in your account, in the event an economic downturn occurs. The amount of money you allocate to each asset is in part dependent on how close you are to your retirement years. If you are a few years away from laying down your tools of work, it is a good idea to keep off the risky assets.
In contrast, those who are still in their 20s can create an investment portfolio that is heavily weighted in the more risky assets such as stocks. This is because they have enough time to fix whatever errors they might make during their investment journey, which is a luxury that those nearing their retirement years are not accorded.
How exactly does one decide on the percentage of their funds that should be allocated to stocks vs. bonds? A common rule is usually to subtract one’s age from 110. The result you get is the percentage of your wealth that should be allocated to stocks. The more risk-tolerant investors can opt to subtract their age from 120, while the risk-averse ones can subtract their age from 100.
Golden Tip on how to diversify your portfolio
For a long time, many investors have stayed in the dark about investing in precious metals as an approach to diversifying their wealth. Generally, most investors only have their funds allocated to paper assets in their 401(k). Paper assets have the potential to give impressive returns, even over the short-term horizon. They can, unfortunately, also be the worst assets to hold on to when the stock market is crumbling. With this in mind, many investors are opting to turn to gold, and for a good reason – it is one of the most stable assets above ground.
If you currently own a 401(k) and are not very certain about its future, then you might want to hear out the retirement investment experts who have something to say about adding gold to your portfolio. As we already know, the main objective of diversifying one’s retirement investment portfolio is to reduce the volatility of one’s returns.
Gold pops up in this discussion, because of its interesting price trend. Gold has historically performed during stock market crashes. This means that adding gold to one’s portfolio can act as a much-needed anchor during stormy financial times.
According to the World Gold Council, gold is a “well-rounded, cost-effective strategic asset, which held even in modest amounts ( typically 2-10 % of a portfolio) can help investors reduce risk without sacrificing their long term returns.
Investors also add other precious metals such as silver, platinum, and palladium, in the IRS-approved forms, to their portfolios, since they all have a low or negative correlation to other tradable assets such as stocks and bonds.
It, therefore, makes a lot of sense to have a portion of your money sheltered in precious metals.
You, however, have to open a self-directed IRA to invest in these non-traditional assets. A self-directed IRA that specializes in the investment of gold is known as a gold IRA. You can always use your gold IRA to invest in other IRS-approved precious metals, though you have to confirm whether your gold IRA’s custodian supports other assets.
2. Rebalancing Your Portfolio
Another vital component of the strategy to protect your 401(k) from a market crash is rebalancing your portfolio. This essentially points to changing how much you have allocated to different assets. The logic is that over time, there are investments that end up faring better than others, while others become potentially riskier to hold. The best fix to such a problem is redistributing your wealth, such as by moving some of the funds allocated to stocks and bonds to other assets.
Financial experts advise that you should invest in a target-date fund, to ensure that you have a continually rebalanced portfolio. A target-date fund is simply a collection of investments that are expected to mature at a particular date in the future. They are structured in such a manner that they automatically rebalance the investments held in them, through moving funds to the safer assets as the target date draws near.
If you, however, prefer picking your own investments for your 401(k) account, it is a good idea to rebalance your portfolio annually. It is not rare to come across financial advisors who recommend rebalancing on a quarterly basis. All you need to do is to sell off the positions that are gradually tipping your portfolio out of balance. You cannot afford to not do this, especially if you are nearing your retirement years since a bad year can put a hole in your portfolio and render you financially unstable.
For the sake of clarification, rebalancing your portfolio does not mean withdrawing your money. It refers to the transactions within your 401(k) which do not result in immediate taxes.
3. Have cash on hand
It is a good idea to have enough cash or cash equivalents to cover about 3 to 5 years’ worth of your expenses. Having cash reserves can help you pay for all unexpected expenditures that can otherwise not be met using a fixed income.
Having cash on hand is also a good approach to the mitigation of a “sequence of returns risk.”, which is essentially the potential danger that arises from the withdrawal of one’s money early in retirement. Most retirees often find themselves withdrawing their money right after retiring due to the occurrence of market downturns. Doing this, unfortunately, diminishes the longevity of one’s retirement portfolio, which is not a very good way to begin your retirement phase.
Having cash reserves enables investors to avoid selling low since they have enough money to meet their living expenses.
4. Keep making contributions to your 401(k) and all your other retirement accounts
Steadily contributing funds to your 401(k) is another viable approach to safeguard it from a market crash. If you cut down on your contributions during an economic downturn, you miss out on the opportunity to invest in various assets at lower-than-usual prices.
Beyond that, maintaining your 401(k) contribution frequency even after your investments have exceeded your expectations is also quite important. It is not rare for investors to be tempted to scale back on contributions during the seasons of global economic instability. If you, however, decide to stay on course, you will end up bolstering your retirement savings, as you also build the fortitude to withstand future volatility.
5. Avoid withdrawing your funds early
Most market crashes elicit fear and confusion from the most salaried employees. It is not an uncommon occurrence to come across investors withdrawing funds from their 401(k) before hitting 59 ½ years. Doing this attracts a 10% penalty, in addition to normal income expenses. It’s therefore quite important for younger workers to ride out the market lows since doing this can help them reap the benefits of the future market recovery.
Also, as highlighted above, you can consider rebalancing your portfolio instead of making an early withdrawal. You may, for instance, start by adding gold to your retirement investment portfolio, just to create some stability for you to cruise through the economically challenging times. Afterward, you can purchase more stock when the market is down, to ensure that your allocation is in check. By purchasing low, or near low, you are best placed to maximize your returns, when the market eventually rebounds.
6. Do not panic when the 401(k) loses value
We have already talked about this in brief, but it does not hurt to emphasize the essence of not freaking out when the figures in your 401(k) are not looking very attractive. It is not fun to check your 401(k) balance just to see that you have lost several thousand dollars in a couple of months.
What you do not want to do is panic and make rash decisions. It beats logic to start taking money out of your account since you already paid a price for your assets. If they lose their value and you sell, you have simply sold your assets for a loss. The best strategy is actually to keep investing so that you can reap in the long term.
Frequently Asked Questions on How to protect your 401(k) from a market crash
1. What can I invest in a 401(k)?
The most common investment option offered in today’s 401(k) plans is mutual funds. There has, however, been a rise in the number of 401(k) plans offering exchange-traded funds (ETFs). ETFs and mutual funds contain a wide variety of securities. Typically, individuals cannot invest in individual stocks, such as Amazon or Facebook, but are required to select one or several mutual funds or ETFs.
2. What is diversification?
Diversification refers to the spreading of your investments around so that the risk exposure to a single type of asset is limited. This is a strategy designed to help minimize the volatility of one’s portfolio over time. It also reduces the probability that one bad event will take out your entire portfolio.
3. What is a market crash?
A market crash is a sudden and dramatic decline in the prices of stocks in the entire stock market, a process that often results in the significant loss of paper wealth. Most crashes are usually a result of panic selling and other unforeseen factors. Generally speaking, a market crash occurs under the conditions listed below:
- A prolonged bullish market ( increase in stock prices)
- Excessive economic optimism
- Situations in which price-earnings ratios exceed the long-term averages
- The extensive use of leverage/margin debt by the market participants
Some other factors that may trigger a market crash include:
- A change in federal laws
- Natural disasters occurring in the economically productive zones
- Large corporate hacks
4. Why do 401(k) owners open gold IRAs to diversify their retirement investment portfolios?
For a lot of people, it is better to do a 401(k) to IRA roll-over. Gold and silver help investors to diversify their portfolios owing to the fact that they have a low correlation with other tradable assets. Many investment experts believe that adding precious metals to one’s portfolio may improve its performance because the market forces that determine the prices of gold often differ from or counter the forces that determine the prices of assets such as stocks and bonds. This relationship works to reduce the overall portfolio volatility.
Also read: What is a 401(k) to gold IRA rollover?
That will be all for this post about how to protect your 401(k) from a market crash. Hopefully, you gained enough insights to help maneuver the stormy financial times as a 401(k) account owner. As you can see, there are several solutions out there for you that you can apply to ensure that you are on the safe side, such that even if you don’t end up having positive growth in the short term horizon, that you 401(k) will have impressive returns by the time you are getting to your retirement years. Let me know if you have any questions with regards to this post – drop them in the comments section and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired!