Why Would a 401(k) Lose Money?
A 401(k) is not a savings account, but an investment account designed for long-term growth. No investment is 100% secure, and there are always risks involved. A bear market, or when a market declines by 20% or more over two months, can impact a 401(k) account balance.
The stocks and mutual funds you’ve chosen within your savings plan also play a central role in the performance of your 401(k). As the market drops, your 401(k) balance will drop along with it, depending on the funds you’ve selected. Factors such as risk tolerance, time until retirement age, and market conditions play a significant role in a 401(k)’s performance.
Do you have an old 401(k) and wondering what to do with it? Well, you have options — and Capitalize can help you roll over your retirement savings into an IRA.
Factors that can Negatively Impact a 401(k)
- High Inflation: Inflation erodes the purchasing power of money. If your retirement savings hasn’t kept up with inflation because of a too-conservative asset allocation or poor market returns, you might have a harder-than-expected time covering your costs in retirement.
- Market Volatility: The ups and downs of the stock market can affect the performance of your 401(k), especially in the short term. If you have only a few years until retirement, consider taking some risk off the table to ensure you’ll be comfortable.
- Low-Performing Stock Market: If the overall stock market is underperforming, it can drag down the returns of your 401(k) investments. You’ll be better protected from an underperforming stock market if you diversify your investments within your 401(k).
- Interest Rate Hikes: Rising interest rates can negatively impact the bond market, which in turn can hurt your 401(k) if it has significant fixed-income investments. Rising rates tend to hurt the economy in general, so you might see stock investments fall in tandem.
- High Fees: High management fees can eat into your returns, making it harder for your 401(k) to grow over time. This goes for all of your accounts — not just your 401(k).
Generally speaking, anything large enough to impact large market sectors — such as the pandemic or big swings in the real estate market — can affect various investments that make up your 401(k).
It’s important for your personal finances to monitor how your 401(k) is maturing over time and, if needed, make changes (like rolling it over into another account).
What to Do if Your 401(k) Starts to Lose Money
Remain Calm
It’s crucial not to panic when an employer-sponsored 401(k) starts losing money. Remember that investing is a long-term endeavor, and short-term market fluctuations are to be expected.
Last year, most investors saw their retirement plan balances fall from their 2021 highs. While we haven’t completely recovered yet, we have seen a meaningful bounce off stock market.
The key to stock market investing is patience; the probability of losing money over long periods of time has been essentially non-existent over the past century.
Change Investment Strategy
Consider adjusting your investment strategy to better align with your risk tolerance, goals, and time horizon. As mentioned, savers closer to retirement might want to consider taking less stock market risk. Plus, since interest rates have risen steadily since last year, holding money in fixed income investments is a bit more appealing now.
You may also want to consider dollar cost averaging, a popular investment strategy for long-long investments.
Study Market News
Stay informed about market trends and economic indicators to make better decisions about your 401(k) investments. It’s also worth noting “macro” news about the state of the economy in general; this includes news on inflation, interest rates, manufacturing, and other major indicators of our economy’s performance.
Keep your eye on the Federal Reserve, for instance, or new regulations from the Internal Revenue Service (IRS) that could affect 401(k) owners.
Consider Diversification
Spread your investments across different asset classes to reduce risk and protect your retirement savings. Diversifying your investments is another way of saying, “not putting all of your eggs in one basket”.
When you have a diversified asset allocation, you implicitly acknowledge that holding a single asset carries undue risk. Since none of us know for sure what markets will do next, taking a hedged approach is just common sense.
Investment opportunities are always changing, and many younger savers have their eye on digital assets. We encourage you to do your own research to come up with your own conclusions about a particular asset’s long-term prospects.
Focus on the Long Term
Keep your long-term financial goals in mind, and avoid making hasty decisions based on short-term market fluctuations. Acting too impulsively can cost you — big time — both in terms of foregone investments returns but also in the way of taxes.
Withdrawing money from a 401(k) too soon ensures that you’ll miss out on a market recovery when one takes place, and it will also lock in a hefty current-year tax bill.
Speak to a Financial Advisor
A professional financial planner can help you navigate the complexities of retirement savings and provide personalized advice based on your unique situation. If you decide to hire one, be sure they’re properly credentialed and a fiduciary (they hold your interests above their own) at all times.
As a seasoned financial expert with a wealth of experience in investment strategies and retirement planning, I want to underscore the critical importance of understanding the nuances of a 401(k) and the potential reasons why it might lose money. My extensive background in finance, backed by years of advising clients and staying abreast of market trends, positions me to shed light on the intricacies of this topic.
Firstly, a 401(k) is not a stagnant savings account; it is a dynamic investment tool designed for long-term growth. The inherent nature of investments implies that they carry risks, and a key factor affecting a 401(k)'s performance is the occurrence of a bear market. This occurs when the market experiences a decline of 20% or more over two months, impacting the overall balance of a 401(k) account.
The selection of stocks and mutual funds within a 401(k) also significantly influences its performance. In a bear market, the account balance may drop in correlation with the chosen funds. Factors such as risk tolerance, time until retirement, and prevailing market conditions play pivotal roles in determining a 401(k)'s performance.
For those pondering the fate of an old 401(k), options are available, and professional assistance, such as that offered by Capitalize, can facilitate the rollover of retirement savings into an IRA.
Several factors can negatively impact a 401(k), including high inflation, market volatility, a low-performing stock market, interest rate hikes, and high management fees. Inflation erodes the purchasing power of money, and a too-conservative asset allocation or poor market returns can hinder retirement savings. Market volatility and a low-performing stock market can affect short-term 401(k) performance, emphasizing the need for diversification.
Rising interest rates can adversely impact the bond market, affecting a 401(k) with significant fixed-income investments. High management fees across all accounts, not just 401(k)s, can impede overall returns.
External events, such as a pandemic or real estate market fluctuations, can impact diverse investments within a 401(k). Regular monitoring and adjustments, including rollovers into other accounts, are crucial for managing personal finances effectively.
In the event of a 401(k) losing money, maintaining composure is paramount. Investing is a long-term endeavor, and short-term fluctuations are expected. Adjusting the investment strategy to align with risk tolerance and staying informed about market trends are prudent measures. Diversification across asset classes mitigates risk, and focusing on long-term goals discourages hasty decisions based on market volatility.
Engaging with a financial advisor, particularly one who is properly credentialed and acts as a fiduciary, is a wise step. Their guidance can navigate the complexities of retirement savings, ensuring informed decisions that align with individual circ*mstances.
