With the advent of coronavirus, resulting economic concerns, and subsequent stock market volatility, it’s no surprise that a lot of business owners and their employees are unsure about what to do with 401(k)s and IRAs.
It’s good to have a plan in place before a market downturn, but if you find yourself in the middle of this without a strategy, it’s not too late. There are at least three things people do or can do in response to the current unpredictability: sell into cash, stay invested, or make a principled rebalance.
I’ll highlight some pros and cons of each approach, and then I’ll advocate for the third.
The first option: Sell into cash. Liquidate everything in your 401(k) or IRA and buy a cash instrument such as a money market fund. We might call this the “wait and see if the market gets better” approach. The advantage is that it can provide a significant measure of psychological relief that comes from knowing you won’t have to endure any more losses. The disadvantage is that by the time the market does get better (i.e., recover), it’s already too late to get back in.
Many people who pulled out in 2008 stayed in cash for years afterward, even though the S&P 500 gained a striking 26.4 percent in 2009 alone. What people are saying when they go completely into cash and stay there is, “I no longer trust the market.”
A second option in a market downturn is to literally do nothing: Keep everything the same and make no changes to your portfolio—what we might call the “ride it out” approach. Fear and panic will advise you at the time that this is a wrong move, yet it is actually a time-tested method, and there at least two advantages: (1) it gives one’s portfolio the opportunity to accumulate more shares at a lower price through reinvested dividends and interest (investing is all about the accumulation of shares), and (2) investors who do this tend to experience better overall returns than those who sell into cash during market volatility.
The disadvantage is psychological: It can be nerve-wracking to sit tight while one’s nest egg sinks with a free-falling Dow, and not knowing when a recovery might occur can be bothersome. This is especially true for business owners who are looking to retire today without an already-in-place strategy for market volatility.
A third option if you have a tax-deferred account (e.g., a 401(k), IRA, or Roth IRA) is to stay invested while making well-timed rebalances to your portfolio. We’ll isolate 20 percent of a hypothetical diversified portfolio to demonstrate.
Imagine your 401(k) holds 10 percent of its overall allocation in a stock fund (let’s call it “ABC stock fund”), and that this fund is down due to the market decline. Imagine as well that your 401(k) also holds 10 percent in a bond fund (we’ll call it “XYZ bond fund”), which has gained money (bonds tend to do this when stocks fall). Your percentage allocations of each are off from their original 10 percent, so to achieve a rebalance you would sell some of XYZ bond fund and use it to buy some of ABC stock fund. This would help to even out and rebalance your portfolio.
This method (which utilizes the time-tested principle of “buy low, sell high”) has a few distinct advantages: (1) it adds additional shares to the stock portion of your portfolio at a lower price point, thus creating the potential for a “spring load” effect for recovery: Stocks tend to grow faster than bonds, and more stock shares in a rising stock market means a potentially faster recapture of losses; (2) it provides a measure of psychological security that the “do nothing” approach does not, because you’re staying invested while actively responding to the market downturn; and (3) it’s an approach based on principle, not fear or emotion.
The disadvantage to this third tactic is that it can be hard to accomplish if emotion does get in the way, or if one doesn’t have the time or inclination to track one’s portfolio carefully. It can also sometimes be hard to accomplish the buys/sells efficiently without trading or rebalancing software. Please note: This approach may cause a taxable event if used in a non-qualified, taxable account. Consult with your tax professional before using this approach outside a tax-deferred investment account.
In a perfect world, you would have an investment plan in place before the market corrects. However, if you’ve found that the current market decline was a surprise and you’re without a plan, it’s not too late to start.
Staying invested and rebalancing are helpful and proven approaches that can have a dramatic impact on your portfolio for years to come. This can help ensure that you’re in the best possible position to achieve your financial, retirement, and estate planning goals.
Eric Runge is owner of Veritas Wealth Management in Lake Oswego, Oregon, and focuses on retirement income planning for business owners ages 50 and up. He holds the Retirement Income Certified Professional designation, as well as the Series 65 registration.
Disclaimer: Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Veritas Wealth Management, LLC unless a client service agreement is in place. Veritas Wealth Management, LLC does not render tax advice.
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.