ScaredyCatGuide to the 401(k) - Part 12: Your 401(k) During Times of Economic Uncertainty

in LeoFinance3 months ago

With unemployment surging in 2020 and the economy likely in recession many people are worried about their 401(k) accounts. The stock market has been a roller coaster the first half of the year and concerns of a scenario similar to 2008 have people worried.

Back then the economy “melted-down” in a fashion not seen for over seven decades. 401(k) investors that were looking for a safe haven were left disappointed into 2009.

During that time it was not about making money, it was more about how to lose less. This is another reason we dove so deep into cleaning up the fees you pay are your investments and 401(k) plan. You pay these fees whether your account balance goes up or down.

Those that had enjoyed the aggressive growth beginning with the 2002 market rebound quickly got burned by those same high-return/high-risk stocks that had pumped up their 401(k) accounts to begin with.

There were some outliers, several stocks in the consumer staples sector did well relative to the market as consumers hunkered down. That still did not prevent the sector from booking a loss of 15.4%

However, that 15.4% loss was the smallest of all sectors in 2008. That loss was practically desired compared to the other sectors like technology and financials that lost 43.1% and 55.3%, respectively.

This goes back to what we discussed in chapter 8, why allocation and rebalancing is so important. In that chapter we focused on the basic allocation of stocks vs. bonds in your 401(k).

ASSET ALLOCATION DEEP DIVE

Allocation can and should be drilled down further. For instance, you can allocate between different stock sectors by selecting funds that focus on those industries.

Those that practiced this would have seen smaller losses in 2008 because those technology funds that provided a lot of the growth the prior six years would not be vastly overweight.

It is important to remember Warren Buffet’s #1 rule of investing: “Don’t lose money.”

This is because as losses get larger, the return needed to recover to break even increases at a much faster rate.

Remember the wonderful power of compounding? Well, in this case it works against you. If $1,000 is invested and it loses 15% then $850 remains.

In order to get even the $850 would need to produce a $150 return. Taking 150 ÷ 850 = 17.6%, the return needed to reach break-even.

Instead, say the $1,000 loses 43% leaving a balance of $570. To reach break-even it would be 430 ÷ 570 = 75.6%.

That is quite the jump considering the difference between the two losses was 28%, but to get back to break-even the larger loss needs to outperform the smaller by 58%.

Do you see why being properly allocated and mitigating loss is so important?

It is not just the downside risk that allocating helps with. The rebalancing gives you the benefits of the rebounding sectors that previously underperformed.

With those big moves occurring in 2008 a portfolio would have seen consumer staples become a much larger portion while technology became smaller.

A fresh rebalancing would have meant upping the allocation in technology stocks. That proved fruitful as technology was the best performing sector in 2009 with a 61.7% return.

Mitigating risk while still leaving opportunity for upside, especially during times of economic uncertainty, is a vital piece to retirement investing. Rather than trying to time the market, let asset allocation do the work for you over time. Be sure to rebalance when needed. Checking on your accounts at least once a year is wise.

Unemployment

Because 401(k) programs are tied to employment of some type, a decrease in employment leads to a decrease in the number of people who are able to contribute. The overall rate of retirement savings goes down and the services that are associated with 401(k) products may very well suffer. This chokes a powerful engine that pumps investment money into markets.

During periods of rising unemployment you will see, more often than not, a shrinking economy and a decrease in the value of most assets classes.

Finding yourself unemployed in one of these periods can be quite the hit to your retirement investing timeline. Since you are no longer earning income from that employer it also means no contributions are being made from you or them. When the economy recovers and markets begin to rebound your 401(k) account isn’t participating in it to full effect.

However, someone in that position may have bigger financial concerns and need to consider withdrawing from their account to pay the bills. This can become tricky as withdrawals on 401(k) plans can affect unemployment insurance benefits.

It is not uncommon for your withdrawn investment “income” to delay the time you'll have to wait before you are eligible to receive benefits, depending upon what state you live in.

Add to this the missed potential gains on your investments and the penalties you incur for early withdrawal. There are quite a few reasons to leave your retirement savings alone in even in the most difficult times. It is a decision not to be weighed lightly.

In the next post we will discuss the conditions of early withdrawal if you do decide to go that route.....

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Last year I planned on adding to my retirement plan but because of the current situation I have put that on hold.

I supposed that is why advisors say to dollar cost average. It's hard to time when to get in the grand scheme. But I agree with you, I'm hesitant to add anything in here.