A down economy is always a tough climate in which to make money -- but it doesn't have to be a tough climate for your retirement savings account. Money management should be for the long term, and a down economy is just a natural part of the business cycle. What's important to remember in a down economy is that your investments, while potentially losing value, are still assets. Assets fluctuate, but they never disappear entirely.
What Effect Does a Down Economy Have on my 401k?
A down economy is generally accompanied by a negative trend in stock markets like the NYSE and NASDAQ -- the virtual marketplaces where stocks in public companies, along with other securities, are traded. Many 401k accounts are comprised of shares of stock in public companies, having either been purchased directly or owned by proxy through shares in a mutual fund. Thus, when these investments decrease in value, the value of a 401k decreases proportionate to the percentage of your investments that are held in stock.
But in many cases, a 401k account isn't comprised solely of shares of public company. Many mutual funds diversify their investments by purchasing an array of financial instruments such as debt, money market investments, and stock. In the case that your 401k investments are well-diversified, as is recommended for any money management strategy, your entire retirement savings portfolio will not decrease proportionally with a drop in the overall value of only the stocks that you held.
In fact, many investors flock to debt during a down economy -- especially debt issued by the US treasury department, which is thought to have no default risk -- because of its stability. In the case that your 401k is comprised of a healthy percentage of debt, the value of your retirement savings investments might actually increase during a down economy. This is a key advantage of asset diversification.
Should I Withdraw My Money From a 401k in a Down Economy?
Withdrawals from a 401k retirement savings account before the holder reaches the age of 59 1/2 are subject to an excise tax which can be up to 20% of the amount withdrawn -- on top of the income tax that must be paid on that money. In short, withdrawing money from a 401k before you're 59 1/2 is costly and reduces the value of your retirement savings account.
Remember that, while a share of stock might decrease in value during a down economy, it still represents the same level of ownership that it did when you purchased it. A share of stock may decrease in an economic downturn, but it also may increase during a strong economy. The old saying goes that you should buy low and sell high -- and selling off your stock during an economic downturn is the opposite of that.
Unless you're facing extenuating circumstances, you should hold your investments for the long term and not react rashly to changes in the economy. An investment into a retirement account is meant to be held for the long term and isn't a "trade" or gamble. Obviously exceptions apply, and you should use your best judgment in determining your 401k account's structure. But if you bought a stock to hold for 30 years, don't lose sight of that investment time line just because its price has dropped -- unless you think its price is not likely to recover and might further decline.
Should I Adjust How My 401k is Invested in a Down Economy?
The most important thing to remember about a retirement savings account, and about money management in general, is that the more diversified your assets are, you more protection you have against shifts in the economy. If your 401k is held mostly in the stock of your employer, consider expanding into other securities and asset classes. Also, invest the maximum that your employer is willing to match -- it's free money.
