My 401(k) Is Losing Money. What Should I Do?

Observing a decline in your 401(k) account can be unsettling. Many investors experience periods when their retirement savings shrink, particularly during market uncertainty. These fluctuations are a normal aspect of participating in financial markets long term. Understanding these dynamics helps you navigate such periods with an informed perspective.

Understanding 401(k) Performance Fluctuations

A 401(k) account typically invests in market-dependent assets, including stocks, bonds, and mutual funds. Their performance is directly influenced by the broader economic environment. Your 401(k) balance naturally reflects prevailing market conditions.

Economic factors play a role in shaping investment performance. Changes in interest rates, inflation, or recessions can significantly impact your holdings. When inflation rises, purchasing power decreases, meaning investments need to generate returns that outpace inflation to maintain real value.

Financial markets operate in cycles, experiencing growth, stability, and contraction. Short-term volatility, temporary drops in market values, is a regular occurrence. Market corrections, declines between 10% and 20%, have historically resolved with an average recovery time of three to eight months.

More substantial downturns, bear markets, involve declines of 20% or more and generally last longer, with recovery periods often extending for one to two years in milder recessions. Despite these fluctuations, 401(k) plans are designed as long-term retirement vehicles, allowing time for investments to recover and grow over decades. This long-term horizon mitigates the impact of temporary market drops.

Assessing Your Personal Financial Situation

Before adjusting your 401(k), evaluate your personal financial circumstances. Your individual situation dictates the most appropriate response to a declining account balance. This assessment involves key factors influencing your investment strategy.

Your time horizon, the years until you plan to retire and draw from your 401(k), is a primary consideration. A longer time horizon provides more opportunity for investments to recover from market downturns. For individuals many years from retirement, temporary losses are less impactful than for those nearing retirement.

Understanding your risk tolerance is important; this involves your comfort level with potential investment losses and your financial capacity to withstand them. Factors like current income, expenses, and other financial obligations contribute to your ability to take on risk. Questionnaires can help gauge your personal risk profile, which typically ranges from conservative to aggressive.

Reviewing your contribution levels to your 401(k) is another step. For 2024, individuals under age 50 can contribute up to $23,000 annually, while those aged 50 and over can make an additional catch-up contribution of $7,500. Total contributions from both employee and employer are limited, generally reaching up to $69,000 in 2024.

Ensure you have an emergency savings fund outside your retirement accounts. Financial experts recommend holding three to six months’ worth of living expenses in an accessible, liquid account. This fund prevents needing to withdraw from your 401(k) during a market downturn, which could lock in losses and incur penalties. A holistic view of your overall financial goals allows for a more comprehensive and stable financial plan.

Strategies for Managing Your 401(k)

When faced with a declining 401(k) balance, specific actions can help manage your account effectively without emotional decisions. Maintaining or increasing regular contributions is a powerful strategy during market downturns. This approach leverages dollar-cost averaging, where a fixed amount is invested at regular intervals, regardless of market price. This means you automatically buy more shares when prices are low and fewer when high, resulting in a lower average cost per share over time.

Rebalancing your portfolio is another step. This involves adjusting your investment allocation back to target percentages by selling assets that have grown disproportionately and buying more of those that have lagged. For example, if your target is 70% stocks and 30% bonds, and stocks have significantly outperformed, you might sell some stock funds and buy bond funds to restore your original balance. This process can be done periodically, such as annually, or when your portfolio deviates by a certain percentage, like 5% or 10%.

Reviewing your investment options within your 401(k) plan is also prudent. Ensure the funds available align with your current risk tolerance and time horizon. Some investment types may perform differently in various economic conditions; for instance, certain stocks or inflation-protected securities can offer better protection against rising prices. Your plan administrator can provide details on the performance and fees associated with each option.

It is advisable to resist panic selling during a market decline. Selling investments when their value is low can lock in losses, preventing your portfolio from recovering when the market rebounds. Historically, markets recover from downturns, rewarding those who remain invested through volatility.

Consulting a qualified financial advisor can provide guidance, especially if you feel overwhelmed or your financial situation is complex. An advisor can help you understand your 401(k) plan options, assist in selecting appropriate funds, and help you stay disciplined during market fluctuations. They can also provide financial planning that integrates your 401(k) with your other assets and overall financial goals, including maximizing tax benefits. While advisors charge fees, their guidance can be beneficial for making informed decisions.