Should You Stop Contributing To Your 401k During A Recession?
Nobody likes to see their portfolio lose money. But in the event of a recession, your 401k will lose value.
While this may seem scary, it is actually an excellent opportunity for long-term investors. Short-term economic chaos creates long-term opportunities for investors.
The stock market has historically recovered from every recession, which is a great reason not to sell or stop contributing.
Still, if you do not educate yourself about the potential outcomes of your 401k, you could make a costly decision based on emotions.
Stock Market Crashes are Normal and Expected
In the short-term, stock prices tend to be random. However, long-term market returns are positive, meaning the markets favor long-term investors.
Even though the long-term expectation of the stock market is positive, there have been many recessions and bear markets throughout history.
However, long-term investors shouldn’t panic during a recession since the stock market has historically recovered from all of them.
The hardest part about investing in the stock market is to refrain from panic selling at the worst times, such as recessions.
Investors must understand that your account value will fluctuate in the short term, but if you continue to buy and dollar-cost average, you will do well over many years.
What is The Average Loss in 401ks During a Recession?
The significant stock market drawdowns in recent history occurred in 2000, 2008, and 2020.
Most people have their 401k invested in a mix of stock market indices like the S&P 500 and bonds, depending on your investment holding period.
According to the Motley Fool, the S&P 500 fell around 38.61% from its highest level during a recession.
Therefore, your 401k may lose nearly half its value in rough economic conditions.
Nobody wants to see their life savings cut in half, but if you keep buying assets on the dip, your 401k will compound and grow massively when the economy recovers.
How Long do Recessions Typically Last?
The average length of a recession since 1926 is about 1.3 years.
Investors may believe they can time the market and avoid the drawdown, but this is a risky game since the market generally recovers when you least expect it.
Some of the best days on the stock market occur when there is a lot of fear. Therefore, you will miss out on the positive gains if you are in cash when these days randomly happen.
One of the worst times to invest in the stock market was before the dot com crash in 2000.
If you invested your money in the S&P 500 at the dot com bubble peak, you would not see any returns on your investment until over a decade later.
However, if you continued to contribute more to your investments during this period, you would own stocks at a massive discount once they go back up over the following years.
While recessions can last for many years, the stock market has recovered and made new highs after every single one.
You will make money during recessions if you have an emergency fund and the patience to hold through all of the market volatility.
Should I Cash Out My 401k?
Deciding to cash out your 401k during a recession is one of the worst moves you can make. Additionally, you cannot claim a capital loss with a 401k retirement account since you already receive tax benefits.
In fact, you would be better off increasing your contributions during recessions to take advantage of the lower asset prices.
The most crucial factor to consider before selling your 401k investments is your investment holding period, or how long you plan on keeping your money invested.
Selling your investments may not be a terrible idea if you plan to retire within the next few years. However, long-term investors that don’t plan on selling for another decade should increase their 401k contributions during recessions.
Skeptical investors can also increase their 401k allocations to bonds during recessions. Some may prefer this method since bonds are risk-free investments, making them safer than investing in the stock market.
However, less risk means less reward, so when the stock market goes back up, bonds will not provide nearly as much return as the stock market.
In 2022, bonds are dropping with the stock market since the Fed is raising interest rates. Therefore, even investors who allocated money to bond funds are still experiencing some short-term losses.
Should I Stop Contributing to my 401k During a Recession: Final Thoughts
If you are planning on holding your 401k investments for another decade or longer, there is no reason to stop contributing to them during a recession.
Recessions are the best time to invest in the stock market since you can take advantage of lower prices.
Even though seeing your account balance drop in the short term can be painful to watch, you should try contributing more to your 401k during recessions.
When the stock market eventually returns, you will have acquired many shares of stock at a discount in exchange for short-term market volatility.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #065
