During bull markets, it is easy to forget that the good times won't last forever. Then, during bear markets, every time your statement arrives it is all too clear that your hard-earned dollars are disappearing along with your hopes of a financially secure retirement.
What should you do when times get tough? These four steps will help you survive and defend your 401(k) plan against the rampaging bruins.
- Several steps can help you survive a bear market, starting with having a solid investment plan to reach your retirement goals.
- Asset allocation and diversification can help you ensure you have the right types of investments in your portfolio to weather a market downturn.
- Watching your 401(k) investments dwindle may cause you to panic and sell. But if your long-range plan is a good one, there's no reason to alter your investment strategy.
- When stock prices are down, it's a good time to buy—consider contributing more to your 401(k), if you can.
Make a Plan
If you don't have a solid plan, now is the time to formulate 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.
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 which types of investments your portfolio should hold.
While putting your plan together, don't forget that diversification can help mitigate risk and increase returns. 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.
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 equity 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.
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 (which would probably require a bull market) that selling now would enable you to reach your goals early.
When the markets drop, everybody wants to sell and get out. The very same investors who were happy to buy stocks when they cost 40% more suddenly feel as if their holdings must be liquidated at any cost. It's illogical behavior driven by panic.
If you saw that something you wanted—a car, a resort weekend, a computer—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.
Over the long term, the stock market has gone up. Use that trend to your advantage.
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.
The Bottom Line
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. A bear market won't either. In time, markets recover. Even if the bear is roaring just when you're retiring, remember that you can—and probably should—keep the account funded.That's part of what thinking long term is all about.