Market crashes are scary. After a long bull market in which the S&P repeatedly hit new record highs, it's hard to see the retirement savings that you've worked for years to save in a 401(k) take a severe hit when the good times come to an end. Yet even though those downward movements are inevitable for long-term investors, they don't have to derail your dreams of financial security and prosperity in retirement.
The key to handling volatility is to be smart about risk management, anticipating worst-case scenarios and adjusting your strategy to allow for them. That way, short-term movements in the Dow Jones Industrials and other key market benchmarks won't tempt you to make bad decisions about the mutual funds and other investments available to you in your 401(k) account. The following five steps will give you a good guide on what to do with your 401(k) when the market crashes.
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1. Do nothing.
The first thing to do is to pause without taking immediate action. Once the crash has happened, there's nothing you can do to turn back the clock and get your lost money back. Often, the worst thing you can do is to sell out after a market crash, because the stock market can bounce back in the short-term and leave you having sold out at the precise bottom of the market. Get your bearings until you can consider your financial position objectively with as little emotion as possible. Then you'll be better able to make a plan that will work for the long haul.
2. Assess the damage.
After you've calmed down a bit, take some time to see how your portfolio performed during the crash. If your overall account balance fell more than the overall market did, then you need to ask whether your portfolio was too aggressively positioned -- or whether the specific mutual funds and other investments you had access to were at fault. If your balance didn't drop as much as you would have thought, then drilling down to see what strategy you used to ease the losses could be helpful in weathering future market volatility.
3. Look more closely at the fund level.
In addition to looking at how your 401(k) in total did, you should see whether the funds you own within the 401(k) had similar or disparate performance. Sometimes, you can identify poor fund choices by how they behave in a market crash. In particular, if a fund didn't perform very well during the market's bull market run and then loses more than its peers in a downturn, then you have to question whether it's truly the best available fund. Often, a lower-cost passive index fund can give you at least more predictable returns.