Bear Spray For Your 401(k)
The 401(k) plan has become the primary retirement savings vehicle for a significant number of investors. During bull markets, it is easy to forget that the good times won't last forever. During bear markets, every time your statement arrives in the mail it is all too clear that your hard-earned dollars are disappearing along with your hopes of a financially secure retirement. So, what should you do when times get tough? These five steps will help you survive and defend your retirement savings against a ravaging bear market.
Make a Plan
If you don't have a solid plan, now is the time to get one. Stumbling through bad times without a strategy makes an shaky situation even more unsettled. If you don't know how much money you need to achieve your goals, you won't even be able to assess the damage when times get tough. (For more insight, read Having A Plan: The Basis Of Success.)
Investing shouldn't be about trying to pick a hot stock or mutual fund and riding it to the moon. You should have a goal and a plan to reach that goal. That goal should include a time frame for achievement - and a backup plan in case things don't turn out as well as expected.
It's All About Asset Allocation
Figuring out your goals should be the first step in your efforts to get your 401(k) plan in good working order. After you've figured out how much money you will need, the next step is to figure out how your investments can help you get there.
In this regard, asset allocation is the key. Understanding your risk tolerance and the likely returns from various types of investments can help you figure out what types of investments your portfolio should to hold. (To learn more, read Asset Allocation Strategies and Achieving Optimal Asset Allocation.)
While putting your plan together, don't forget that diversification can help mitigate risk. This can be particularly important if your employer's stock makes up a large percentage of your retirement portfolio. If the stock market is in trouble, having too many eggs in one basket could scramble your returns. (Read Introduction To Diversification and The Importance Of Diversification to learn how finding the right balance of investments can reduce risk and increase returns.)
Regardless of your current situation, a down market is not the time to make radical changes. Whatever you do, don't just blindly sell your stock funds and move all of your assets to a money market fund. Although the urge to flee to safety can be nearly overpowering, your current losses are all on paper. If you sell now, you lock in those losses. If retirement is still years or decades away, you have time to let your portfolio recover. (For related reading, see The Art Of Cutting Your Losses.)
What should you do? If you had a long-term investment strategy in place before the markets took a dive, it's time to revisit your plan. Are your goals still the same? Is your retirement still many years in the future? If the particulars of your situation haven't changed, there's no reason to change your investments. Stock prices rise and fall. Just because they have fallen doesn't mean your strategy should change. The price of a given stock or mutual fund shouldn't be the driving factor in your decision-making process unless that price is high enough that selling now would enable you to reach your goals early.
When the markets take a dive, everybody wants to sell and get out of the market. The exact same investors who were happy to buy stocks when they cost 40% more, suddenly feel as if they must be liquidated at any cost. It's illogical behavior driven by panic. For example, if you saw something that you wanted - a car, a vacation or other consumer goods - was on sale, you'd snap it up in minute. Investments are no different. Just as fund prices don't rise forever, they don't fall forever either. If you bought when prices are higher than they are today, selling low is not the key to investment success. Buying low is a far better idea.
Instead, think about those prices. Stocks are on sale! Buy them. If you can afford to invest a greater percentage of your income, now is the time to increase contributions to your 401(k) plan. If your employer offers a company match on your contributions, increase you contributions at least to the level that will let you get the match. It's a guaranteed return on your investment and will help you recoup some of the losses caused by a bear market. (For more insight, see Adapt To A Bear Market.)
Your 401(k) plan is a long-term investing tool. Use it accordingly. Remember, over the long-term, the stock market has historically gone up. This trend is your friend; use it to your advantage. Even the Great Depression didn't stop the long-term trend. Today's troubles won't either. In time, markets will recover. Think long-term and invest accordingly.
When all is said and done, if you can't handle what's happening in the financial markets, call a professional and delegate your investment planning to an experienced, impartial advisor with a proven track record.