5 Ways to Protect Your 401(k) From a Stock Market Crash

Protect Your 401(k) From a Stock Market Crash

Despite what the 2010s may have felt like, the stock market cannot go up forever. Corrections typically happen every few years when stocks decline 10% or more from their most recent peak. These can even last several months at a time. Stock market crashes, on the other hand, are less common than corrections, but are more abrupt and severe. Look no further than the 2008 financial crisis or the 2020 crash ushered in by the coronavirus pandemic. More market uncertainty has reared its head in 2022. But preparing for market volatility ahead of time is possible. A financial advisor can help you protect your retirement savings from market volatility.

Protecting Your 401(k) From a Stock Market Crash

Any time you put your money in the stock market or other investments, you always run the risk of losses. While you can make largely educated decisions, things don’t always go to plan. Also, because you’re talking about something as important as your retirement, emotional decision-making can come into play.

Despite the above, there are many strategies, simple and complex, you can use to mitigate risk. For instance, spreading your assets across multiple types of investments and areas of the market can allow you to avoid the volatility that comes with stock-picking and concentrated investment positions.

Everyone has short-term expenses that periodically arise. For example, you might need to repair your car, replace a broken household appliance or pay for a medical procedure. Long-term expenses are even more prevalent, including student loans and mortgages. However, the best thing you can do is treat your retirement savings just as important as all of your other needs. This will ensure your pool of retirement funds will continue to grow over time.

Below are some of the most influential strategies you can use to minimize losses in your portfolio, even if a stock market crash comes around. Just remember that you can never eliminate risk entirely, though.

Don’t Panic and Withdraw Your Money Too Early

Protect Your 401(k) From a Stock Market Crash

Surrendering to the fear and panic that a market crash elicits can cost you. Withdrawing money early from a 401(k) can result in hefty IRS tax penalties, which won’t do you any favors in the long run. It’s especially important for younger workers to ride out the market lows and reap the rewards of the future recovery.

Even people nearing retirement age may rebound from the crash in time for their first withdrawal. Consider the coronavirus-fueled crash of 2020 as a case study. The Dow Jones Industrial Average, which notched an all-time high of 29,551.42 on Feb. 12, 2020, fell to just above 19,000 by March 15, 2020. Then on April 15, 2021, it posted an intraday high of more than 34,000. Spooked investors who pulled their money from the market in March 2020 missed out on the bull market that pushed the DJIA to record highs by November 2020 – just eight months later. The Dow reached its all-time high of 36,585 on Jan. 3, 2022.

Diversify Your Portfolio

Finding the right asset allocation is crucial to protecting your 401(k) from a stock market crash, while also maximizing returns. As an investor, you understand that stocks are inherently risky, and as a result, offer higher rewards than other assets. Bonds, on the other hand, are safer investments but usually produce lesser returns.

Having a diversified 401(k) of mutual funds that invest in stocks, bonds and even cash can help protect your retirement savings in the event of an economic downturn. How much you choose to allocate to different investments depends in part on how close you are to retirement. The further you are from retiring, the more time you have to recover from market downturns and full-fledged crashes.

Therefore, workers in their 20s would likely want a portfolio more heavily weighted in stocks. While other coworkers nearing retirement age would probably have a more even distribution between lower-risk stocks and bonds to limit exposure to a market drop.

But how much of your portfolio should be invested in stocks vs. bonds? A general rule of thumb is to subtract your age from 110. The result is the percentage of your retirement portfolio that should be invested in stocks. Investors who are more risk-tolerant can subtract their age from 120, while those who are more risk-averse can do the same from 100.

However, the above rule of thumb is fairly basic and limiting, as it doesn’t allow you to account for any of the specifics of your personal situation. A more comprehensive approach would be to build an asset allocation that includes your goals, risk tolerance, time horizon and more. While you can technically create your own portfolio allocation plan, financial advisors typically specialize in it.

Rebalance Your Portfolio

Protect Your 401(k) From a Stock Market Crash

Rebalancing your portfolio, or changing how much you have in different assets, is another vital component of protecting retirement savings from crashes. The idea is that over time, some investments may fare better than others, changing the percentage of money in each asset and potentially exposing you to more risk. By rebalancing, you bring the percentage of money invested in stocks and bonds back in line with your original investing target from the section above.

The easiest way to ensure your 401(k) is continually rebalanced is to invest in a target-date fund, a collection of investments designed to mature at a certain time. Target-date funds automatically rebalance their investments, moving to safer assets as the target date approaches.

But if you pick your own 401(k) investments, you’ll want to rebalance your portfolio at least once a year. Some financial advisors may recommend rebalancing as often as once a quarter. You can do this by selling off positions with gains that have tipped your portfolio out of balance. This is especially important for investors who are nearing retirement. It’s also worth noting that rebalancing isn’t the same as withdrawing money. These transactions are happening within your 401(k) and won’t immediately result in taxes.

Keep Some Cash on Hand

Some financial professionals recommend retirees have enough cash or cash equivalents to cover three to five years’ worth of living expenses. Having cash reserves can help pay for unexpected expenditures that a fixed income may not otherwise be able to cover.

Cash on hand can also mitigate what’s called “sequence of returns risk.” That’s the potential danger of withdrawing money early in retirement during market downturns and, thus, permanently diminishing the longevity of a retirement portfolio. By selling low, the longevity of the investor’s portfolio is jeopardized. However, with cash reserves, retirees can withdraw less money from their 401(k) during a market decline and use the cash to cover living expenses.

Continue Contributing to Your 401(k) and Other Retirement Accounts

Steadily contributing to your 401(k) is another way to protect it from future market volatility. Cutting back on your contributions during a downturn may cost you the opportunity to invest in assets at discount prices. Meanwhile, maintaining your 401(k) contributions during a period of growth when your investments have exceeded expectations is equally important. The temptation to scale back your contributions may creep in. However, staying the course can bolster your retirement savings and help you weather future volatility.

Bottom Line

Protecting your retirement savings from a stock market crash requires you to pay special attention. Keep a close eye on your asset allocation and investment variety, and rebalance when needed. Continuing to contribute to your 401(k) through both bull and bear markets can bolster your retirement savings for the future while remaining calm during times of volatility will keep you positioned to capitalize on the eventual recovery.

Tips for Protecting Your 401(k)

  • Consider talking to a financial advisor about investment strategies and protecting your 401(k). Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • A target-date fund will automatically rebalance over time. This will ensure you remain primarily invested in stocks early in your career. Then, as you near retirement, it’ll shift to safer, more conservative investments.

Photo credit: ©iStock.com/D-Keine, ©iStock.com/martin-dm, ©iStock.com/Pears2295

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