Market crashes are scary. After a long bull market in which the S&P repeatedly hit new record highs, it's hard to see the retirement savings that you've worked for years to save in a 401(k) take a severe hit when the good times come to an end. Yet even though those downward movements are inevitable for long-term investors, they don't have to derail your dreams of financial security and prosperity in retirement.
The key to handling volatility is to be smart about risk management, anticipating worst-case scenarios and adjusting your strategy to allow for them. That way, short-term movements in the Dow Jones Industrials and other key market benchmarks won't tempt you to make bad decisions about the mutual funds and other investments available to you in your 401(k) account. The following five steps will give you a good guide on what to do with your 401(k) when the market crashes.
1. Do nothing.
The first thing to do is to pause without taking immediate action. Once the crash has happened, there's nothing you can do to turn back the clock and get your lost money back. Often, the worst thing you can do is to sell out after a market crash, because the stock market can bounce back in the short-term and leave you having sold out at the precise bottom of the market. Get your bearings until you can consider your financial position objectively with as little emotion as possible. Then you'll be better able to make a plan that will work for the long haul.
2. Assess the damage.
After you've calmed down a bit, take some time to see how your portfolio performed during the crash. If your overall account balance fell more than the overall market did, then you need to ask whether your portfolio was too aggressively positioned -- or whether the specific mutual funds and other investments you had access to were at fault. If your balance didn't drop as much as you would have thought, then drilling down to see what strategy you used to ease the losses could be helpful in weathering future market volatility.
3. Look more closely at the fund level.
In addition to looking at how your 401(k) in total did, you should see whether the funds you own within the 401(k) had similar or disparate performance. Sometimes, you can identify poor fund choices by how they behave in a market crash. In particular, if a fund didn't perform very well during the market's bull market run and then loses more than its peers in a downturn, then you have to question whether it's truly the best available fund. Often, a lower-cost passive index fund can give you at least more predictable returns.
4. Reposition for your time horizon.
In deciding whether to make changes, you'll want to see how your asset mix compares with an ideal allocation for someone with your time horizon. Usually, the longer you have before you need the money from your investments, the more aggressively you can invest. Yet what some find after a market crash is that they already had a riskier portfolio than they thought, in which case less post-crash adjustment is needed.
5. Consider saving more.
Finally, if you now find yourself behind where you wanted to be at this stage in saving for retirement as a result of the market crash, then looking for ways to boost your retirement savings can be your best way to make up lost ground. The advantage of investing after a market crash is that your odds of immediate gains are better, and longer-term returns tend to improve as well. At the very least, if you have access to an employer match but aren't contributing enough to take full advantage of it, increasing your savings to get all the free money your employer will give you is generally worth the effort.
Make the most of your 401(k)
Right after a crash is when most people least want to consider their financial situation. But by being smart at the time when it matters most, you can have a better chance of making your 401(k) do as much as it can to help you create the retirement you've dreamed of having.