Your 401(k) was supposed to be your ticket to a nice retirement. And it sure seemed like you were heading in the right direction, right up until 2020 happened. Now, your account balance is down and you're wondering where you went wrong. Did you pick the wrong funds? Should you have kept your savings in cash instead?
For the vast majority of people, saving enough for a decent retirement requires regular savings contributions over a long period of time. That, unfortunately, is the only thing that's straightforward about retirement saving. The rest of it -- picking funds, evaluating performance, deciding whether to hold or sell -- can feel like guesswork. And then when your portfolio balance goes down instead of up, you're even more uncertain.
Know that you can reset and move forward from this. A good place to start is by building your confidence and knowledge around evaluating performance. First, know that the broader market is your benchmark. If one of your funds has dropped in value, you don't really know what that means until you compare it to market trends. A 5% loss in value, for example, is bad when the market has risen 5%. But it's good when the market has fallen 10%.
To understand those broader market trends, look to stock market indexes. You've likely heard of the S&P 500. This index is a good representation for the entire U.S. equities market and a good benchmark for the domestic equities funds in your 401(k). If you have other types of funds in your portfolio, say a bond fund or international equities funds, you'd compare those to indexes representing those sectors. You might look at the Bloomberg Barclays U.S. Aggregate Bond Index and the MSCI EAFE Index, for example.
If you're invested in target-date funds -- they have a year in the fund name -- you won't find a comparable index. These funds have portfolios that are diversified across different asset classes. But you can use Morningstar's mutual fund comparison tool or something similar to see how your fund measures up to other target-date funds with the same year.
What to do when your account is down
Review how each of your funds performed relative to an appropriate index, and you'll start to see why your account balance is down. There are really only three reasons. Either the market as a whole was down, and your investments moved with the market. Your investments could also be underperforming. Or, you sold off some of your investments when the market fell in March.
When the market is down
In the first quarter of 2020, the S&P 500 lost 30% of its value. Since then, the index has slowly climbed back to recoup much of that loss. As of mid-June, the index is down about 5% for the year. If your equities funds are down around 5% for the year, they're moving with the market -- and that's about the best you can expect. Staying with the market is your goal, since it's rare that you'll outperform the market. There just aren't many funds that do that consistently.
You probably don't need to take any big actions other than wait for the recovery, which will happen eventually. You could read up on your funds as a learning experience, though. Look at the fund's investing strategy, risk profile, and expense ratio. If you don't see this information when you log into your 401(k), ask your plan administrator if fund prospectuses are available.
When you have a dud fund
If you own a U.S. equities fund that's down substantially more than 5% for the year, that fund might be a dud. In that case, you'll have to look at other fund choices in your 401(k). A good place to be in is an S&P 500 index fund with a low expense ratio, say, less than 0.25%. That type of fund should deliver something close to market-level performance.
You can sell off one fund and buy another in your retirement account without tax implications. You may have to take a loss on the underperformer, but you'll be better positioned to move up with the market going forward.
When you sold at the bottom
Finally, your retirement account may be down because you sold in March when things got dicey. The value of the positions in your retirement account floats up and down as conditions change -- but only until you sold them for cash. Once you sold, you limited your losses but took yourself out of the running for a recovery, too.
You now have a bunch of cash sitting in that 401(k). It's probably earning next to no interest. Your best option is to reinvest in low-cost index funds and increase your contributions if you can. Then make a commitment to leave those positions alone, even if the market goes through another rough patch.
Rinse and repeat
Repeat this exercise every six months and you'll build confidence around making investment decisions in that retirement account. You'll also get more comfortable with the idea of moving with the market, even when the market is struggling. Long-term, stock market growth averages about 7% annually. To get near that 7% with your own investments, you have to ride out the ups and downs. The unfortunate reality is that investors who sell when things go south tend to have lower returns. Don't let that happen to you.