The stock market is notorious for its volatility, often resulting in severe declines. The most recent stock market crash occurred in 2020, which caused many individuals to lose significantly large sums of their retirement savings.
However, extreme drops in the stock market are nothing new, with other notable crashes occurring in 1929, 1987, 1997, 2000, 2008, 2015, and 2018.
As a result, we can put our money on another crash occurring inevitably soon.
With those odds, 401(k) investors shouldn’t put their nest egg in one basket. Otherwise, you could end up with nothing as you near retirement. Instead, here are nine ways you can protect your 401(k) from another stock market crash:
Educate Yourself About Investing and the Stock Market
Reading and learning about investing and the stock market helps you to make educated decisions. This will help you invest your money and possibly protect your 401(k) from a market crash.
Luckily, you can learn about investing and the stock market from hundreds of resources, such as whitepapers and financial magazines. You can also practice trading with the help of a broker who will help explain everything related to investment and the stock market, such as asset classes, order types, and volatility.
Seek Professional Investing Advice
After reading and learning about investing and the stock market, consider seeking professional counseling from a financial adviser or a 401(k) specialist.
Seeking professional investing advice may help you understand other aspects of investing, receive custom-tailored suggestions and recommendations to help your savings grow, and minimize the risk of losing money.
Don’t Withdraw Your Money Early
The fear and panic of a market crash may lead some people to withdraw their money early. However, that is a terrible thing to do to your 401(k). Withdrawing your money before retirement can result in hefty IRS tax penalties and permanently diminish the longevity of your retirement portfolio.
Have Cash on Hand for Emergencies
Having a cash emergency fund helps you from reaching for your retirement account and withdrawing your money early.
Financial experts recommend retirees have a cash reserve equivalent to cover at least six months’ worth of living expenses. This will help you pay for unexpected expenditures without bearing the harmful consequences of withdrawing your money early from your 401(k).
Diversify Your Portfolio
Diversification is one of the best ways to shield any investment from economic downturns such as a stock market crash. When you diversify your portfolio, you spread the risks across several types of investments.
So, if one asset class performs poorly or crashes, the rest of the assets may mitigate the blow. Therefore, finding the proper asset allocation is important to protect your 401(k) from a stock market crash.
Stocks are inherently risky but may offer higher rewards than other assets. On the other hand, bonds are safer investments that produce lesser returns. There are five main types of bonds: savings, agency, treasury, municipal, and corporate. Each type of bond has its advantages and disadvantages.
Treasury bonds, or t-bonds, are considered one of the safest investments because the government guarantees that investors will receive the face value of their investment if they hold it to the maturity date.
In other words, investors that have the bond until maturity are guaranteed their initial investment. Additionally, investors receive semiannual dividends until maturity, which ranges between 10 and 30 years.
You may also want to consider investing in a gold IRA because gold may act as a hedge against inflation, deflation, currency devaluation, and stock market crashes.
A gold IRA or a precious metals IRA functions the same as a regular IRA. The only difference is that it holds physical gold coins or bars instead of holding paper assets.
So, consider diversifying your portfolio and investing in stocks, bonds, gold coins, and cash to help you protect your retirement savings in an economic downturn.
Choose Your Asset Mix Carefully
Choose the different types of investments that go into your portfolio carefully. For instance, investing in stocks may help you grow your retirement fund faster.
However, in case of a market drop or crash, you could lose plenty of money. Therefore, investors must be educated when choosing their asset mix to avoid trouble.
Also, the longer you have before retirement, the more time you have to recover from market downturns and crashes. Therefore, the younger you are, the better to invest in stocks and take risks because the latter offers much higher returns than other assets.
Moreover, even if you see temporary losses, stocks have a historical tendency to go up again in the future. Therefore, it is wiser for people in their twenties to have a portfolio more heavily weighted in stocks.
On the other hand, as you get older and near retirement age, consider having a more even distribution between stocks, bonds, and gold bars to limit exposure to a market drop.
Rebalance Your Portfolio Frequently
Rebalancing your portfolio is restoring or changing how much you have in different assets. For example, if you own 40% of U.S. stocks and they increase in value, you can sell some of the stocks and invest the proceeds in other asset classes.
Moreover, if you rebalance your portfolio and buy other assets before a market crash, you may offset the loss or observe a minor impact.
Therefore, rebalancing your portfolio is another important component of protecting retirement savings from crashes.
One of the best ways to ensure your 401(k) is continually rebalanced is to invest in a target-date fund. The latter is a collection of investments designed to mature at a specific time. It automatically rebalances investments, moving to safer assets as the target date approaches.
If you pick your own 401(k) investments, it is recommended to rebalance your portfolio at least once a year – ideally once a quarter. You can rebalance your portfolio by selling off positions that have made gains.
Note that these transactions are happening within your investment account and won’t result in tax penalties.
Take Out a Permanent Life Insurance Policy
Consider taking out a permanent life insurance policy. While it will not protect your 401(k) from a stock market crash. It can help you avoid dipping from your 401(k) early. Even though permanent life insurance is often more expensive than term life insurance, it has the benefit of producing tax-free income and avoiding probate.
A permanent or whole life insurance policy guarantees your beneficiaries will receive a death benefit no matter what age you pass. Consequently, the death benefit will produce a lifetime guaranteed cash value stream.
In addition, in an economic downturn where you need money, you can borrow against the cash value of your insurance policy without paying any interest on the loan and avoid the temptation to withdraw from your 401(k).
Keep Contributing to Your 401(k) During Downturns
You may get tempted to scale back your contributions in a stock market crash. However, contributing to your 401(k) may protect you from future market volatility and mitigate market losses during downturns.
For example, you could buy stocks at a lower price to compensate for some of your purchased stocks at a higher price.
Therefore, cutting back on your contributions during a downturn may cost you the opportunity to invest in assets at discount prices.
Sum Up
Investors always risk losses when they invest their money in the stock market or other investments. Nonetheless, there are many ways to protect your 401(k) from a stock market crash.
The first step is to educate yourself about investing and the stock market, even seeking professional investing advice from experts.
Then, diversify your portfolio across different asset classes to help reduce your portfolio’s volatility. Also, have cash on hand for emergencies to avoid withdrawing your money early and incurring penalties.
Next, rebalance your portfolio frequently to ensure all asset classes remain at their original percentage with one another.
Finally, remember to contribute to your 401(k) even in downturns to benefit from lower prices.
FAQ
What Are the Safest 401(K) Investments During a Recession?
As an investor, you know that no investment is 100% safe. Nonetheless, bonds are considered good investments during a recession but produce lesser returns than inherently risky stocks.
More specifically, treasury bonds or t-bonds are considered one of the safest investments because of the aforementioned government guarantee that investors will receive the face value of their investment if they hold it to the maturity date.
Gold is also considered a safer investment during a recession because it is a safeguard against an economic crisis.
In addition, gold has an intrinsic value because it is a tangible asset. As a result, it is not as susceptible to volatility and dramatic changes in price as stocks.
Moreover, gold’s value often increases during recessions as the value of currency decreases.
Can You Lose Your 401(K) If the Stock Market Crashes?
If your 401(k) is entirely in stocks, you could lose all your investments if the stock market crashes.
However, if your 401(k) is partially invested in stocks, that part may crash, but the rest may stay intact. Therefore, it is best to diversify your portfolio to protect yourself from economic downturns.
What Happens to My IRA if The Stock Market Crashes?
Your IRA could decline in value if the stock market crashes because a traditional IRA is tied to specific stocks.
Unfortunately, since an IRA is tied to the stock market, it is unprotected from potential volatility and downturns. As such, there is a risk that your IRA will significantly decline if the stock market crashes.
