How can investors protect their 401(k) and other retirement savings from being depleted when they’re watching the stock market drop?
All three major stock indexes fell at the market open on Monday. The S&P 500 SPX, +0.73% fell more than 7%, causing a halt in trading for 15 minutes, while the Dow Jones Industrial Average DJIA, +0.44% fell more than 5% and the Nasdaq Composite COMP, +0.97% was down 4.3% that morning. The indexes rebounded at the open on Tuesday.
The last month has been hard on investors. Stocks fell into correction territory in February, around the time fears of the coronavirus spreading and affecting global economies began.
For most investors, the money already in 401(k) plans should stay there — especially if retirement is a few decades away, advisers say. But there are strategies to avoid losing that money — and even making more. “It is very important to have a plan irrespective of market conditions — in good and bad times,” said Jay Spector, a partner and wealth adviser at Barton Spector Wealth Strategies in Scottsdale, Ariz.
It’s also important to note that the money is not yet lost until investments are sold. Even if an account balance is lower today than it was yesterday because of market volatility, the account holder hasn’t yet lost that money — unless of course they were to sell their investments.
Here are a few ways you can protect your 401(k), according to financial advisers — some suggestions have little to do with the account itself.
Don’t touch it
Market volatility is normal, as is an investor feeling overwhelmed by his account balance moving sporadically. The best time to come up with a financial plan is before the markets act up — and to stick with it, said Scott Bishop, executive vice president of financial planning at STA Wealth Management in Houston. “Now may turn into a very good buying opportunity, but you should not ‘speculate’ on emotion,” he said. “Rather, have a plan and follow it.”
Portfolios should be diversified with numerous asset classes, under both equities and fixed investments. “Asset allocation and diversification still work,” said William Parrott, president and chief executive officer of Parrott Wealth Management in Austin, Texas. “A balanced portfolio of stocks, bonds and cash will treat you well over the long term.” Financial advisers will typically incorporate the risks of market volatility and potential downturns when drafting a financial plan and portfolio’s asset allocation.
Cash is, at times, king
“You can always look at cash as being ‘safe,’” said Thomas Rindahl, a financial adviser at TruWest Wealth Management Services in Phoenix. Along with contributing to a 401(k), workers nearing retirement should keep some money outside of the market. Some investors may feel compelled to buy as much in stocks as they can while prices are down, but they also need to set some cash aside for emergency funds, as well as a pile they could draw down if they do retire soon.
Those nearing retirement should try to refrain from withdrawing from their retirement portfolios, as a way to protect themselves from the “sequence of returns” risk, which is when investors withdraw from their principals and not gains. Doing so potentially deflates any future returns.
“If you need your money in one year or less, do not invest in the stock market,” Parrott said. He suggests keeping money in cash or short-term investments, such as U.S. Treasury bills or Certificates of Deposit. For those retiring within the next five years, at least three years’ worth of expenses should be in cash, short-term CDs or U.S. Treasurys, he added. “For example, if your annual expenses are $100,000, then your cash holdings should be $300,000.”
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Annuities, which are insurance products, are another way to provide protection of principal, as well as generate guaranteed income, Rindahl said.
There are many types of annuities, which are created using contracts that should clearly spell out the terms, such as time frame for premiums and benefits paid. Annuities overall can be complex products and difficult to understand, so it’s important investors work with financial planners and insurance professionals to make the safest decision for their personal situations. There are a few questions they should ask before incorporating one into their retirement plan.
Congress passed sweeping retirement legislation called the Secure Act in December, which incorporated numerous rules to help bolster Americans’ future financial security. One provision was to expand access to annuities in 401(k) plans, in an attempt to safeguard Americans from outliving their nest eggs.
Keep adding money to the plan
Another way to protect your 401(k)? Keep contributing to it. Many investors use drops in the market as an opportunity to buy into equities, and then wait for them to rebound.
Those nearing retirement may want to hold on to a job, or for those already in retirement, take up part-time work to add an extra source of income. Continuing to work is one way to avoid withdrawing from retirement assets, and is beneficial because it adds more to the portfolio. “Find ways to generate income,” said Jake Northrup, founder and a financial planner at Experience Your Wealth in Bristol, R.I. “The ability to turn up and down your income is such a powerful planning tool to protect against down markets.”