Don’t Panic: What to Do With Your 401(k) When the Stock Market Drops
You know the story of “The Tortoise and the Hare”? It turned out slow and steady won the race.
That applies to investing, too.
Last year, as the Dow Jones Industrial Average rose and fell daily — and even hourly — to the economic effects of COVID-19, the financial roller coaster ride left plenty of investors feeling a bit queasy.
If you had a 401(k) or IRA, you may have felt your own steep drop in the pit of your stomach. As it turned out, though, the 2020 stock market crash — and more importantly, the subsequent recovery — provided a good lesson in playing the long game as an investor.
Here’s what you need to keep in mind if you’re inclined to panic about your 401(k) amid turmoil in the stock market.
How Your Retirement Investments Work
To understand why you shouldn’t panic too much about your retirement accounts, you need to know how they work.
A 401(k) is an employer-sponsored investment plan while Individual Retirement Accounts — either traditional or Roth IRA — are typically set up by the individual to invest money toward retirement.
If it’s a 401(k) or traditional IRA, you get the tax benefit up front and pay when you withdraw; with a Roth IRA, the withdrawals are tax-free. Either way, by adding money on a regular basis, these accounts let you grow your nest egg that you can live on in your retirement.
In the beginning, you’ll have more time to take risks on investments — like stocks — and when you get closer to retirement age, you’ll shift investments to less-risky categories like bonds and cash that don’t lose their value during a market slump.
So even if there’s a dip in the stock market, you’ll have time to recover if you’re younger and you’ll be better protected from fluctuations as you near retirement.
What to Do With Your 401(k) During a Slump
Watching your 401(k) balance take a tumble isn’t anyone’s idea of fun. We get it.
But a down market is not a time to panic, according to Certified Financial Planner Holly Donaldson of St. Petersburg, Florida.
That’s because the cash component of your account, as well as the contributions you should absolutely continue to make, can be used to buy up more funds at rock-bottom prices.
So selling is the last thing you want to do because you’d be locking in your losses.
In fact, Donaldson suggests ignoring your newsfeed if it puts you in a panic about your retirement accounts.
“What I advise is you use the calendar and not the news,” said Donaldson, who suggested checking in with your portfolio on a quarterly basis rather than a daily one.
Even if your account balance takes a nosedive, don’t withdraw your money from an IRAor 401(k) — the penalties for early withdrawal are substantial.
She noted that it typically takes the stock market one to two years to correct itself, so a single day — or even a few weeks — of volatility should not change your long-term strategy.
Don’t try to time your investments. Instead, use dollar-cost averaging, which means you invest on a regular schedule no matter what’s happening in the stock market.
Avoiding the stress of hourly updates on your investments is key to not only a balanced financial portfolio but your mental health, too.
“If a 27-year-old wants to increase their chances of suffering chronic anxiety, then yeah, sure, look at your 401(k) every day,” she said.
And even if you’re closer to retirement, Donaldson recommended talking to a financial planner or speaking to your employer’s 401(k) representative to ensure your portfolio has the right mix of stocks, bonds and cash.
Slow and steady. Wins it every time.
Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Read her bio and other work here, then catch her on Twitter @TiffanyWendeln.