Setting up a well-diversified 401(k) plan takes a lot of time and money. So when your 401(k) starts to decline and keeps doing so for some time, you have every right to worry and start contemplating the next move to protect your investment. But depending on what’s causing the decline, you might not need to do anything after all.
The reason your 401(k) keeps going down can be an overly aggressive investment strategy or a market-wide loss in stock value. Rethinking your asset allocation is one way to fix the issue, but it could mean missing out on potential earnings. The other fix is to wait things out.
Read on for an eye-opening discussion on why your 401(k) keeps going down and the best ways to handle the situation.
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Table of Contents
Why Your 401(k) Keeps Going Down?
There are two potential explanations for the downward trend in the value of your 401(k):
- Your 401(k) is too aggressive.
- Market fluctuations
Let’s explore how each of these factors may cause your 401(k) to decline.
Your 401(k) Is Too Aggressive
By “aggressiveness,” I’m referring to the nature of your plan’s asset allocation, which loosely translates to how you split your 401(k) among the various investment options.
Typically, 401(k) savings are invested in mutual funds and sometimes individual stocks. Mutual funds are the safer bet of these two options, but different funds carry different levels of risk depending on the type of underlying investments.
Generally, the more stock a mutual fund holds in its portfolio, the more volatile it is.
Similarly, the more individual stocks you hold in your portfolio, the more volatile it is. Since volatility and risk level go hand in hand, 401(k) plans with portfolios comprising mainly individual stocks and/or stock funds are deemed too aggressive.
What does this have to do with your 401(k) going down?
Simple: If most of your 401(k) is invested in stocks and/or stock funds, the value of your retirement plan will largely depend on the performance of these investments. If they fluctuate a lot (which they almost always do), that change will reflect in the value of your 401(k).
So if you’ve been noticing a downward trend in your plan lately, it could be because it’s invested too much in stocks/stock funds that have been losing recently.
Market Fluctuations
Fluctuations in the stock market can significantly affect the value of your 401(k). If the market experiences a decline, your retirement plan will take a hit, too, because some of your investments will lose value.
Market declines greater than 20% (from the previous market high) are known as bear markets. The opposite of that is a bull market, where the market gains by a similar percentage from a previous low.
There have been several bull and bear markets in history. Between 1926 and 2018, the average bear market duration was 1.4 years, with the cumulative loss averaging at -41%. More recently, COVID-19 triggered a bear market.
Forbes notes that on March 23, 2020, the S&P 500 index fell 34% from its February 19, 2020 peak, effectively registering one of the worst market drops in history.
There are several takeaways from these numbers, and among them is the fact that a bear market can last anywhere between a month to more than a year. That means as a 401(k) participant, you might have to live with a downward trend in the value of their retirement plan for months.
So if your 401(k) has been losing value for some time, you might want to check the market performance. Fortunately, most market declines (including bears) have historically recovered and gone on to hit new highs.
What To Do if Your 401(k) Keeps Going Down?
When a 401(k) starts losing money, the usual go-to move for most investors is to sell their holdings. Some even stop contributions altogether. However, these two aren’t always the right decisions, especially the latter.
So, what should you do when your 401(k) keeps going down?
Depending on what’s causing the decline, you have two options:
- Revisit your asset allocation.
- Wait it out.
Here’s a detailed explanation of each of these two options.
Revisit Your Asset Allocation
Revisiting your 401(k)’s portfolio asset allocation may be an ideal solution if the downward trend in the value of your retirement plan is due to an overly aggressive investment strategy. However, you need to be careful before you reconsider your asset allocation because that decision has several implications.
Switching to safer holdings might cause you to miss out on significant earnings.
Typically, adopting a more conservative investment approach means reducing the amount of money invested in stocks and stocks funds. Why? Because these investment options carry a higher risk than bonds and bond funds.
While going conservative might address your short-term worries about your 401(k) losing money, it isn’t the best way to grow your money long-term. Typically, stocks and stock funds are better for this purpose, even though they’re more volatile.
So, when is it right to change your asset allocation?
Generally, it’s best to change to a more conservative approach when your needs change or if you realize that you got your asset allocation wrong the first time you set it up.
But if your goals are still the same, and your initial asset allocation was perfectly designed to suit them, it’s best to ignore the short-term fluctuations in the value of your investments and focus on the long-term goal.
Alternatively, you can swap out some of your investments for target-date funds. By definition, target-date funds are Exchange-Traded Funds (ETFs) or mutual funds designed to grow your investment via an approach optimized for a given time frame.
Usually, investors choose these investment vehicles with a future retirement date in mind.
So if you’re looking to retire in 2050, you can choose a 2050 target-date fund. Initially, the fund’s portfolio is aggressive, consisting primarily of stocks. The rationale is that since you won’t be needing the money anytime soon, you can afford to take more risk and grow your investment significantly.
As your retirement date approaches, the fund adjusts its stocks to bonds ratio, shifting to a more conservative strategy to minimize risk. This way, you get substantial assurance that your money will be available when you need it.
Switching to target-date funds is especially a sound move for 401(k) participants with a tendency to change their asset allocation due to short-term securities volatility. You set everything up and forget about it, helping you stick to your initial investment decisions and grow your money without worrying too much about short-term declines.
Wait It Out
Exercising a bit of patience can help you get through 401(k) losses caused by market trends.
Historically, stock markets have always recovered from even the worst declines, and you don’t need to go too far back in history for evidence of this. The market bounced back from the 2008 crash and has stabilized from the March 2020 crash, too.
If the past is anything to go by, short-term market losses have often been offset by more significant gains in the long run.
Of course, the past doesn’t necessarily predict the future, especially in stock markets.
But think about it this way: The losses you see in your 401(k) only actualize when you cash out. In other words, you only realize losses when you sell一and not when you’re still holding onto an investment because its value can increase in the future.
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Conclusion
For quick reference, here’s a summary of what we’ve covered in this post:
- The reason your 401(k) keeps going down is either an overly aggressive investment strategy or a market-wide decline in stock prices.
- To fix the situation, you can either revisit your asset allocation or wait it out, depending on what’s causing the decline.
With the former solution, you’ll want to think carefully about your decision because switching to a conservative asset allocation can mean missing out on significant returns.
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