Over the past few years, the market has no doubt tested the patience and resolve of some investors. Inflation has made things more expensive to buy, higher interest rates and a slowing economy may be contributing to higher debt levels, and a bear market has caused most investments to lose a lot of value.
These factors can all make it tempting to alter your retirement planning, but it is important to not let short-term issues affect your long-term strategy. Here are three things you should definitely not do in the face of market turbulence while planning for retirement.
1. Don't reduce your contributions
If you are contributing to a retirement plan at work or have an individual retirement account (IRA) or your own personal portfolio of stocks and investments, you may consider dialing back the amount you contribute to save money, have a bigger paycheck, or stem investment losses. But the long-term loss of reducing your contributions from, say, 4% to 2% far outweighs any short-term "gain" you may see.
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If you made $50,000 per year and contributed just 2% to your 401(k) instead of 4%, you'd have $1,000 more in your paychecks every year. That would be about $27,000 over 20 years, assuming a 3% annual raise, in your pocket.
But if you kept it at 4% and got the full company match of, say, 4%, and got a 10% annual return on your portfolio, which is roughly the long-term average for the S&P 500, you'd have almost $300,000 over 20 years. So really, it is a no-brainer.
If you do need some additional income, do your best to find it elsewhere, whether that means making a budget and cutting expenses; downsizing on your car, home, or other payments; or working a side hustle just to get through the rough patch. You will be glad you did in the long run.
2. Don't tap into your 401(k) early
The one place you should not look for additional income is your 401(k) plan. For starters, there is a 10% penalty for most withdrawals before age 59.5, so if you wanted to take out $25,000 to meet expenses and are younger than that, you would likely lose 10% right off the top, or $2,500, in penalties unless an exception applied. That withdrawal, which is now $22,500 after the penalty, would be considered income, so you would have to pay income taxes on that amount at your tax rate, which would be 22% if you make $50,000.
In addition, the withdrawal would obviously reduce the amount in your 401(k) by, in this case, $25,000. But don't forget, you would also lose out on the investment return, the company match, and the compounding on that $25,000. A 10% annual return alone on $25,000 would grow to about $170,000 after 20 years.
A somewhat better solution would be to take out a loan to cover costs, if necessary. Most companies even allow you to take out a loan from your 401(k) plan without penalty, as long as you pay it back within the allotted time frame. Ultimately, you are just paying yourself back. But you're missing out on investment returns on that borrowed money until you repay the loan.
3. Don't mess with your asset allocation
When the market hits a rough patch, like it did in 2022, investors tend to make wholesale changes to their portfolio. But you want to suppress that urge, because ultimately, when you make major shifts based on current market conditions, you are engaging in market timing.
This is ineffective for a few reasons. First, shifting your allocation from, say, 70% stocks and 30% bonds because the market is down to something more conservative, like a 50/50 mix, will only lock in your losses. Then, when the stock market starts to improve, you are missing out on the gains in the early part of a bull market run.
The S&P 500, over the long run, with dividends reinvested, has returned about 10% per year since it was first launched. While last year it was down 19%, the year before it was up almost 29%, and this year, it has gained 14% YTD. Over the past 10 years, it has posted an annualized total return of 12.7%, and over the past 20 years, as of June 22, it has a 9.9% annualized total return.
When you are planning for retirement, you are planning for the long term, so there is no need to respond to short-term fluctuations. In fact, the longer the time frame, the more aggressive you can be in your asset allocation and stock choices.
However, as you get closer to retirement age and withdrawals, you may want to gradually shift to a more conservative mix, as you will need the money soon. The best plan is to consult an advisor or plan administrator for the strategy that works best for you.
