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You work hard saving and investing to build up your 401(k) or other retirement accounts, so it’s natural to be worried about the impact of a possible recession on your portfolio. But remember that saving for retirement is typically a long-term investment goal, and recessions are a normal part of the economic cycle.
Here’s what to know about your 401(k) during a recession and how to protect your retirement savings.
What happens to 401(k) accounts in a recession?
The value of a 401(k) account, or any retirement account, always depends on how the account is invested. For many people who are still decades away from retirement, their portfolios will largely consist of stocks, which may suffer declines during a recession or economic slowdown.
Investors who hold mostly bonds or fixed-income investments, may hold up relatively well compared to stock investors, though bonds can lose money too, despite being less risky than stocks in general.
Trying to identify a recession in advance and repositioning your retirement account accordingly is not likely to be a winning strategy. Markets often move well in advance of changes in the economy and sometimes move in fear of a slowdown, even though a recession may never materialize.
In 2022, as the Federal Reserve hiked interest rates to slow the economy and bring down inflation, stocks and bonds both declined, as investors worried about a possible recession and higher interest rates sent bond prices tumbling. The S&P 500 fell about 18 percent in 2022 while the Morningstar U.S. Core Bond Index fell about 13 percent.
But a recession still hasn’t come and there are growing hopes of a soft-landing for the economy. An investor who sold stocks in late 2022 due to concerns about a slowdown would have locked in losses and missed out on the S&P 500’s 17 percent year-to-date gain as of August 2023.
How to protect your 401(k) account in a recession
Recessions are a normal part of the economic cycle and you’ll experience several over your investing life. Trying to avoid them entirely is just about impossible, but there are some things you can do to set your 401(k) account up for success when a recession hits.
1. Don’t try to time the market
One of the best ways to handle recessions when it comes to investing is to just accept that they will occur from time to time. Don’t think you can time the market by jumping in and out of stocks at just the right time – always selling at the highs and buying at the lows. It doesn’t happen and you’ll likely end up with worse results if you attempt this strategy.
2. Continue your regular contributions
You can avoid the trappings of being a market timer by continuing to make your regular contributions to your 401(k) or other retirement accounts. By continuing to make regular contributions, you’ll benefit when prices fall, which allows you to buy more shares for the same amount of money. Your account value will benefit when the economy improves and prices rise.
3. Increase your contributions
It may take some courage, but increasing your contributions to retirement accounts during a recession can be a great financial move. You benefit by buying a lot more when prices are down, setting your portfolio up for future success when the economy recovers.
New York investment manager Davis Advisors ran a study showing the impact of investing more during a downturn. It compared three hypothetical investors who had bought $10,000 of an S&P 500 index fund at the market peak in 2007 and their different behaviors at the market lows in 2009.
An investor who sold at the lows to go into cash would have ended 2022 with $5,138, while an investor who held on would have ended 2022 with $33,420. But an investor who added $10,000 at the market lows would have ended 2022 with $108,119.
Boosting your investments when prices are down can be one of the smartest long-term moves for your portfolio.
Recessions can be scary times for investors, as markets fall and concerns about rising unemployment spread throughout the economy. But that shouldn’t cause you to overreact in your 401(k) or other retirement accounts. Avoid the urge to sell and continue to make regular contributions. If you can, consider investing additional money when prices are down, which can help you reach your ultimate goal of retirement faster.