How will a recession affect your 401(k)?
When recession talk heats up, financial questions abound. One of the most common centers on how to protect your 401(k) from a stock market crash. While a repeat of the 2008 financial crisis isn’t likely, how the economy will be shaped by trade wars and interest rate movements bears watching. A downturn could mean a number of things for retirement savers, says Justin Richter, senior wealth advisor at Mariner Wealth Advisors. The severity of the recession, whether retirement funds would need to be tapped for income and how portfolio allocation aligns with an individual’s risk tolerance and time horizon are all considerations. Savers can use these eight rules to manage their workplace retirement plans when the economy slows.
Pay attention to asset allocation.
When the stock market becomes more volatile, investors may have thoughts like, “Should I move my 401(k) to bonds?” This could offer a sense of security in the near term but it’s important to avoid becoming short-sighted. Richter says it’s better to ensure that a retirement portfolio is invested in a way that doesn’t necessitate sudden changes if a slowdown occurs. “A plan participant should avoid the temptation to attempt to time the market,” he says. Those closer to retirement should be focused on minimizing volatility while younger workers can look for opportunities to grow their portfolios. “The investors who have allocated properly should be able to ride out the waves of a recession without losing sleep,” Richter says.
Maintain the pace on contributions.
How much to put in a 401(k) during a recession is something workers may struggle with if they’re concerned about a declining stock market. Charlotte Geletka, managing partner at Silver Penny Financial, says investors shouldn’t be put off by gloom-and-doom financial headlines. “When the stock market is down is the best time to invest in your 401(k),” she says. That’s because elective salary deferrals can stretch further when stock prices drop. Re-evaluating current contribution rates and potentially increasing that rate are strategic moves to consider when the economy seems to be in a slump. Sticking to a long-term retirement investment approach that includes consistent contributions can help balance out down periods over time.
Don’t jump the gun on withdrawals.
Continuing to invest in a tax advantaged plan during a slump may seem like a gamble, and for some workers it may be tempting to cash out early to avoid potential losses. The better move is keeping a downturn in perspective and understanding how market cycles operate. “In most cases, if there is a recession, you will see your account value go down due to market volatility,” says David Blackston, founder of Blackston Financial Advisory Group. Those younger than age 55 who aren’t planning to retire in the next 10 years shouldn’t allow themselves to be prompted into cashing out of their plan, he says. Instead, investors should concentrate on reducing the amount of risk they’re exposed to and remember that time is on their side.
Look at the big picture.
A 401(k) may be the centerpiece of a retirement planning strategy but there are other things to factor in as well when the economy begins to wobble. Taking a comprehensive view of assets held in workplace plans, individual retirement accounts and taxable accounts, as well as looking to other potential income sources such as Social Security or annuities, can help keep economic fears at bay. Chart your course, then stay the course, says Monika Hubbard, institutional retirement consultant at Unified Trust Company. She suggests meeting with a retirement plan advisor to better gauge income needs and how to go about meeting those needs, regardless of economic shifts. “Remain invested and diversified, don’t look at your account balance and don’t panic,” Hubbard says.
Gauge cash needs wisely.
When times are tight, workers may turn to their employer-sponsored plans as a source of cash. Thinking ahead can help sidestep situations that would put a drain on plan assets. “If you need to use the 401(k) to take distributions for cash flow or required minimum distributions, make sure you set aside the cash you will need for the next six to 12 months,” says Ken Van Leeuwen, founder and managing director of Van Leeuwen & Company. “This way, if a recession occurs, you will already have the cash set aside and will not be forced to sell at lower prices.” Making this move when the economy is doing well can help ease financial pressure during slower periods.
Avoid taking a loan from your plan.
Loans can be just as detrimental as withdrawals when the economy begins to lose steam. “Investors should be especially careful about taking 401(k) loans in a contracting economic environment where their job might be at risk,” says Chad Parks, founder and CEO of Ubiquity Retirement + Savings. “If you don’t have the money to repay the loan, you could be at risk for a huge tax liability and a penalty charge, just when you can least afford it.” Loans can also be problematic if the plan bars workers from making new contributions while the balance is outstanding. The value of existing assets in the plan may shrink and savers aren’t able to offset that with new investments.
Actively look for bargains.
Dipping stock prices can be a boon for 401(k) contributors, says Ric Edelman, co-founder of Edelman Financial Engines. Instead of pulling back or moving into more conservative vehicles, investors should be prepared to capitalize on lower prices to shore up stock and mutual fund holdings. Edelman says refusing to invest while prices are dropping is a costly mistake. “Remember, recessions occur about every four years, on average, and they last about 10 months,” he says. “In every case, stock prices reached new highs after every recession.” Looking for stocks that may have taken a price hit but still maintain solid fundamentals could pay off when the economy rebounds and those same stocks begin to rise in value.
Keep risk capacity in sight.
Risk tolerance and risk capacity are two different things. The former refers to the level of risk an investor is comfortable taking on. The latter is the amount of risk needed to achieve investment objectives. Jason Laux, owner and retirement advisor at Synergy Group, says the best 401(k) rule to follow in a recession is to match investments with current goals and capacity for risk. Once that’s been handled, the next step is to avoid reactionary moves. “When a plan matches investors’ goals and capacity for risk, their investments will perform as expected,” Laux says. “When our goals and risk tolerance don’t line up with our investments, we see an unexpected performance and make emotional investment decisions.”
Rules for managing your 401(k) in a recession:
— Pay attention to asset allocation.
— Maintain the pace on contributions.
— Don’t jump the gun on withdrawals.
— Look at the big picture.
— Gauge cash needs wisely.
— Avoid taking a loan from your plan.
— Actively look for bargains.
— Keep risk capacity in sight.
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