Understanding the basic cycles of the stock market can help make sure you don’t make big mistakes that could negatively impact your retirement savings long-term. In this article we will talk about why a stock market downturn can actually be beneficial to your 401k savings long-term and what to do with your 401(k) during recessions.
What Happens to Your 401(k) in a Recession?
A recession or stock market crash can reduce that value of your 401(k) in the near-term. While impossible to predict, a recession could happen in 2023.
This happens because during any recessionary period, stock market correction, or bear market (when the market drops by 20% for a prolonged period of time), the overall value of the stock market will decrease. This means that no matter what you are invested in, the value of your account is likely to go down temporarily.
This is not a reason to panic.
If you have a 401(k), you are an investor. As investors, we need to expect to see 3 to 5 recessions during our lifetime. We also need to know that bear markets occur roughly every 3.5 years. Translation? Bear markets happen all the time. We should expect them to occur regularly and know that they will impact our investments in the short term.
On the positive side, we can also expect that bear markets will end and that the stock market will return. Bull markets are when the market sees a 20% increase over a two month period. Bull markets tend to last longer than bear markets. After every bear market or recession in history, the stock market has returned to record highs.
What You Shouldn’t Do With Your 401(k) When the Market is Down
Whenever the stock market takes a downturn, many people will start to pull back on contributions. When you stop contributing you not only lose the tax advantages of reducing your taxable income, you also miss an opportunity to grow your retirement savings further. Keep reading to learn why this is actually a huge opportunity to grow your wealth.
Some people will also cash out old 401(k)’s from previous employers to avoid further losses.
As long as you don’t sell your stocks or cash out your 401(k), you haven’t actually lost any money. Cashing out your old 401(k)’s will subject you to a 10% penalty and you will miss out on the opportunity to benefit from a stock market return.
What You Should Do With Your 401(k) in Recession or Bear Market
Continue to Contribute to Your 401(k) Even When the Market is Down
If we continue to have a down market in 2023, you have the opportunity to buy into the stock market at lower prices. When the stock market returns (which historically it always has), your money will grow along with the increasing value of the stock market.
Getting educated on the basic cycles of the stock market is one of the best ways to continue to invest through a recession with confidence.
Stock market history clearly shows that we should expect that the stock market is going to drop significantly at least every few years. Knowing that this is a common occurrence can help us feel less panic during market downturns.
The history of the stock market also shows that bear markets usually recover and the value of the stock market increases to higher levels. This offers bigger returns to investors that stay invested and continue to contribute during a down market.
Reduce 401(k) Fees To Keep More of Your Money
Most Americans don’t realize that their 401(k) has fees. Understanding what these fees are can help you save thousands of dollars. Did you know the average American will spend over $138,000 in fees? This can add up to a few additional years that we have to work in order to retire!
There are two typical types of fees: investment fees called expense ratios and administrative fees.
Each investment that you have in your 401(k) has a fee called an expense ratio. This ratio is just an annual percentage of fees you have to pay for each fund in which you invest. You can think of this as the operating cost of a fund.
If you don’t know what fund you are invested in currently, you are probably invested in something called a target date fund, and these funds often have high fees. Learning exactly how to pick your own investments in your 401(k), such as index funds, can help you keep more of your money and earn higher returns in your 401(k).
When you invest in funds with high fees (high expense ratios), you are decreasing the amount of money you will keep in your account. This means you have less money that can benefit from the power of compounding.
Your 401(k) also has administrative fees. This fee is charged to pay for things like the platform and the maintenance of that platform that is being used to manage your 401(k). These fees are usually unavoidable until you leave a company. Finding this number can be challenging but you can always email your 401(k) provider or ask HR. Expect these fees to run around .4% and 1.4%.
Roll over old 401(k)’s into a Traditional or Roth IRA (taxes may apply)
Now that you know that your old 401(k)’s sitting with your former employer have administrative fees, you’ll want to get rid of those fee asap.
The best way to do this is to rollover old 401(k) into an IRA (individual retirement account). This will give you more options of what to invest in and will reduce the overall fees you are paying.
You may decide to roll over your old 401(k) into a Roth IRA, which is an individual retirement account that uses after tax money. This means that you contribute with after tax dollars now, but that the account will grow tax free and you will get tax free withdrawals in retirement.
Depending on how you are currently contributing to your 401k, you will likely have to pay taxes when you roll your money over to a Roth IRA, but you will then be able to have that money grow tax free and get tax withdrawals in retirement. For many, it’s worth paying the taxes now to get them out of the way.
The other benefit of rolling over your 401(k) during a bear market is that the value of your 401k is lower than it has been because the stock market is down. This means that the amount you will have to pay taxes on is lower than it has been!
You’ll also likely have a wider selection of investment options once you roll over your 401k into an IRA. You’ll be able to find investments that best fit your needs and goals and a bigger option of funds with lower or even zero fees.
Final Thoughts On Managing Your 401(k) in a Recession
Don’t wait to take control of your finances and your 401(k). Continuing to contribute, lowering your fees, and rolling over old 401(k) accounts to IRA’s can help you continue to build wealth even in an uncertain economy.
If you’re ready to make the most of your 401(k), check out your free 401(k) checklist to learn more.
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