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

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

Stocks and bonds are traded in bear territory. And given today̵[ads1]7;s circumstances, it’s reasonable to assume the markets will remain volatile for a while.

Interest rates are rising rapidly in the US and Europe due to government efforts to curb rampant inflation. The fear of recession remains. And a steep fall in the British pound combined with rising UK debt costs is causing concern.

After being climbed in the first half of 2022, that is get some back lost ground, stocks are once again deep in the red for the year, with the S&P 500 down more than 20% so far this year. The S&P US composite bond index, meanwhile, is down around 14%.

And investors can see much more churn over the next year.

“Markets are likely to be volatile — both up and down — over the next six to 12 months as the Federal Reserve continues to raise interest rates in the fight against inflation,” said Chris Zaccarelli, chief investment officer of the Independent Advisor Alliance. “If you plan to buy stocks at this time, you need to be patient and hold those positions for a much longer time frame than many people are used to — potentially two to three years, in some cases.”

While it may be a bumpy road ahead, here are some ways to reduce the potential damage to your long-term nest egg.

Bearish markets can be a bear on your psyche. There may be times when you are tempted to sell your stock investments and move the proceeds into cash or a money market fund.

You will tell yourself that you will move the money back into stocks when things improve. But doing so will only lock in your losses.

If you’re a long-term investor — which includes those in their 60s and early 70s who may be retired for 20 or more years — don’t expect to outsmart the current downtrends.

When it comes to investing successfully, “It’s not about timing the market. It’s timing the market,” says Taylor Wilson, a certified financial planner and president of Greenstone Wealth Management in Forest City, Iowa. “During bull markets, people have a tendency to believe that the good times will never end, and during bear markets they believe that things will never be good again. Concentrating on things you can control and implementing proven strategies will pay off over time.”

Say you had invested $10,000 in early 1981 in the S&P 500. That money would have grown to nearly $1.1 million by March 31, 2021, according to Fidelity Management & Research. But had you missed just the five best trading days during those 40 years, it would have only grown to about $676,000. And if you had sat out the best 30 days, your $10,000 would only have grown to $177,000.

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

“This is difficult for many people, because the knee-jerk reaction is to stop contributing until the market recovers,” said CFP Sefa Mawuli of Pavlov Financial Planning in Arlington, Virginia.

“But the key to 401(k) success is consistent and ongoing contributions. Continuing to contribute in down markets allows investors to buy assets at cheaper prices, which can help your account recover more quickly from a market downturn.”

If you can swing it financially, Wilson even recommends increasing your contributions if you’re not already maxed out. In addition to the value of buying more at a discount, he said, taking a positive step can offset the anxiety that can come from seeing your nest egg (temporarily) shrink.

Life happens. Plans change. And so can your time horizon until retirement. So check to see that your current allocation to stocks and bonds matches your risk tolerance and your ideal retirement date.

Do this even if you’re in a target-date fund, Wilson said. Target date funds are aimed at people who will retire around a given year – for example 2035 or 2040. The fund’s allocation will become more conservative as the target date approaches. But if you’re someone who started saving late and may need to take on more risk to reach 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 in organizations that hire his firm to provide financial wellness advice.

So he’s heard from people across the spectrum expressing concern that they “can’t afford to lose” what they have. Even many educated investors wanted out during the downturn early in the pandemic, he said.

Struthers will advise them not to panic and to remember that downturns 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’ll lose some people and they’ll be worse off.”

And it has been particularly discouraging for investors to see that bonds, which are meant to reduce the portfolio’s overall risk, are also down. “People lose faith” Struthers said.

So instead of trying to counter their fears, he’ll try to get them to do something to ease their short-term worries but do the least long-term damage to their nest egg.

For example, some may be afraid to take enough risk in their 401(k) investments, especially in a falling market, because they fear losing more and having less of a financial asset if they are ever laid off.

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

“Just knowing they have that comfort money there helps them not panic,” Struthers said.