Building up your 401(k) or other retirement accounts through saving and investing requires hard work and dedication. It’s natural to feel concerned about how a potential recession could impact your portfolio. However, it’s essential to remember that saving for retirement is a long-term investment goal, and economic downturns are a normal part of the economic cycle.
Here’s what you need to know about managing your 401(k) during a recession and safeguarding your retirement savings.
Understanding 401(k) Performance During a Recession
The performance of a 401(k) account, or any retirement account, is heavily influenced by how the account is invested. For individuals who are still years away from retirement, their portfolios often consist of stock-based funds, which may experience declines during a recession or economic slowdown.
Investors with a significant portion of bond funds or fixed-income investments may fare better compared to those heavily invested in stocks. However, it’s important to note that bonds can also incur losses, albeit being generally less risky than stocks.
Attempting to predict a recession in advance and adjusting your retirement account accordingly is usually not a successful strategy. Market movements often precede economic changes, and sometimes market fluctuations occur in anticipation of a slowdown even if a recession doesn’t materialize.
In 2023, as the Federal Reserve raised interest rates to curb inflation and slow the economy, both stocks and bonds experienced declines. Investors’ concerns about a potential recession and higher interest rates led to a drop of around 18 percent in the S&P 500 and a 13 percent decline in the Morningstar U.S. Core Bond Index.
Despite these declines, a recession has yet to occur, and there are growing expectations of a smooth economic transition. An investor who sold stocks in late 2023 due to economic worries would have incurred losses and missed out on the S&P 500’s more than 60 percent gain since then as of September 2024. Seeking guidance from a financial advisor can help you navigate market fluctuations and safeguard your investments.
Strategies to Protect Your 401(k) During a Recession
Recessions are a natural part of the economic cycle, and you are likely to experience several throughout your investment journey. While completely avoiding recessions is impossible, there are steps you can take to position your 401(k) for success during economic downturns.
1. Avoid Market Timing
One of the most effective ways to manage recessions in investing is to accept that downturns are inevitable. Trying to time the market by constantly buying and selling stock funds in an attempt to capitalize on market highs and lows is unlikely to yield positive results. It’s better to maintain a long-term investment approach.
2. Maintain Regular Contributions
By continuing your regular contributions to your 401(k) or other retirement accounts, you can avoid the pitfalls of market timing. Consistent contributions allow you to purchase more shares when prices are lower, ultimately benefiting from market recoveries and price increases.
3. Increase Contributions
While it may require courage, increasing your contributions to retirement accounts during a recession can be a wise financial decision. Investing more when prices are down enables you to acquire more assets at a lower cost, positioning your portfolio for long-term growth when the economy rebounds.
A study conducted by New York investment manager Davis Advisors demonstrated the impact of investing during a downturn. Comparing different investor behaviors during market lows in 2009, the study showed that those who added to their investments during downturns significantly outperformed those who sold or held onto their investments.
Enhancing your investments during market downturns can be a strategic move for long-term portfolio growth.
Conclusion
While recessions can be unsettling for investors, it’s important not to overreact in your 401(k) or retirement accounts. Avoid the temptation to sell during market downturns and continue making regular contributions. If possible, consider increasing your investments when prices are low to accelerate your path to retirement.