Where should I move my 401(k) gains before the bull stock market ends, in preparation for a market crash?
My 401(k) accounts do not have the option to automatically sell at a stop point. How do you recommend that I lock in my gains before the bull stock market ends? Is it better to move my gains into my 401(k) money market or move them into my 401(k) defensive stock option (for example, a utilities fund)?
This is the question that seems to be on every clients mind that we meet with. I am going to go a bit against the grain of most traditional advice because I am strongly of the mindset that every investment should have a protective stop loss point attached to it, and this includes your 401K. Your 401K probably will follow the movements of the SPX (S&P 500) since the mutual funds available will probably have simillar price movements. There is no way of knowing when the bull market will end, but there is a systematic approach to moving up your stop loss using the SPX as a proxy for the market overall. Until the stop loss is hit there is not a strong reason to be out of the market other than fear, but if you have a plan to react quickly then your fear can settle.
The million dollar question is where to draw the "line in the sand" and where to get back in after the drop. In the past I have written about the importance of understanding fair price areas in the market (you can find the article here) and how you use them to set stop loss points. What I would say to do would be to simply set an alert on the SPX line you choose, and once the Line in the Sand gets hit move your portfolio into positions you will be more comfortable with in a down market.
You can certainly start to get more defensive if you wish. Remember, the famous quote from Peter Lynch though " People have lost way more money preparing for the next correction than in the actual correction itself". An easy way to do it is to set your future contributions to be fixed income heavy to gradually move you more conservatively.
Your portfolio should be allocated based on your goals and time horizon. If you feel exposed with too much stock fund percentages, you can shift to some bond funds for continued interest to fight inflation. However, no one knows how long the bull market will last, so be sure you are comfortable with lower returns that typically comes with lower risk. An Exchange Traded Fund (ETFs) is a great way to diversify and balance your portfolio, which can be engaged through a rollover to an IRA.
Hi, Specific to your question about money market funds versus defensive stock such as utility fund- I want to point out that the two are vastly different. Although people often use utility stocks as a proxy for income it is not fixed income and comes with equity risk. For example, utility stocks as represented by the Vanguard utility ETF (VPU) was down almost 28% in 2008- although that was better than the market (S&P 500) which was down 38% it was still much worse than the performance of a money market fund. In addition, utility funds could get hurt if interest rates continue their climb. So, in my opinion utilities should fall in your equity bucket whereas a defensive bucket could be a portfolio of bonds of various duration and credit rating constructed in an appropriate manner.
In terms of preparing for a market crash you should do it by matching your portfolio to your risk profile (Ability and willingness to take risk) and your objectives and not by timing the markets. Rebalancing your portfolio betweeen risky and defensive buckets exlained above could help as well.
We have done some analysis on this topic. You can read it at the end of the newsletter here. I am appending some of the text below:
People often tell us they have a substantial amount of cash and are waiting for the market to crash to deploy it. Our response is that it is impossible to predict when the market will crash next and more importantly how much it will rally before it crashes. We decided to investigate the performance of various buy the dip (drawdown) strategies and compare it to a buy and hold strategy.
Between 1926 and 2017, stocks earned an excess return (i.e. market return more than cash returns) of 6.46% per year. (The market return during that period was 9.89% per year) On the other hand, a strategy of purchasing stocks after a 10% dip (Drawdown) and then holding till the prior peak was reclaimed and then selling to go back to cash until the next 10% dip, would have earned an excess return of only 2.07% per year. To put that in perspective, $10,000 invested in the buy and hold strategy in 1926 would have grown to about $3 million in 2017, whereas it would have grown to $64,800 in the ‘buy the 10% dip’ strategy. (Both amounts are in addition to earnings on cash.)
The takeaway is that on average waiting for the market to crash is not a good investment strategy. Investors are better off creating a sound investment strategy in line with their objectives and sticking to it. Robust portfolio construction, selecting suitable investment vehicles, tactical allocation and macro aware investing can add additional value.
Great question, at our firm, we are of the belief that we are in yet another massive financial bubble. That being said, there are times you want your money 'playing' on offense, (when markets have low risk) at other times on defense, and then other times, bring in the special teams, (when markets have high risk) to use the football metaphor.
We are advocates of using the historical movement of assets in previous stock market crashes to help investors determine how much downside they are comfortable with, regarding their investments. This helps set their ‘asset allocation’.
There are tools to help investors understand the risks inside of their investments. You should consider seeking out a service like this, and then determine where your investments should go, based upon downside risk, or what our industry calls, 'drawdown'.