Are you meeting your retirement goals? Addressing 401(k) performance in volatile markets

A 401(k) is a long-term investment vehicle designed to grow over the decades. Understanding how to navigate uncertain periods is key to protecting your nest egg’s potential. Simply having a plan may not be enough, especially during periods of market volatility. If your 401(k) seems to be underperforming lately, it’s likely a reflection of broader economic conditions. 

While you can’t control the market’s ups and downs, you can control your decisions and investment strategies. Here are some tips on what to do when market conditions may be impacting your 401(k). 

1. Consider dollar-cost averaging

Growing your retirement savings is not necessarily a linear trajectory. Market conditions and downturns are a normal part of the long-term investment cycle. That’s why you may want to consider dollar-cost averaging, in which you contribute to your 401(k) regularly even during periods of market instability. By purchasing assets when prices are lower, you can reduce your average cost per share over time and position yourself for stronger gains when the market recovers. By investing the same dollar amount regularly from your paycheck:

• When the market is down and share prices are lower, your fixed dollar contribution buys more shares of your 401(k) funds.

• When the market is up and share prices are higher, your fixed dollar contribution buys fewer shares.

Over time, this helps smooth out your average cost per share and reduces the risk of putting a large sum of money into your 401(k) investments right before the market drops significantly.

Let's look at the example below, thinking about your paycheck deductions into a 401(k) fund:

Imagine that each month for four months, your 401(k) deduction is $200, and this goes into a specific fund.

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Over these four months, your 401(k) has invested $800, and your average cost per share for this fund is $8.89 ($800 divided by 90 shares). This illustrates how the consistent $200 contribution from your paycheck allowed for the purchase of more shares when the price decreased to $8 in months two and three. In contrast, a single investment of the entire $800 during the first month at the higher $10 price point would have resulted in acquiring only 80 shares.

Therefore, the automatic paycheck deductions in your 401(k) make dollar-cost averaging a simple and effective strategy for long-term saving, helping you buy into the market consistently through its ups and downs.

2. Readjust your 401(k) asset allocation

Market valuations will naturally cause your asset allocation to shift over time, necessitating occasional adjustments. When your portfolio's current allocation significantly deviates from your intended target, it's time to consider rebalancing. Rebalancing involves selling and buying funds to restore your portfolio to the desired asset mix, ensuring it continues to align with your long-term financial goals and risk tolerance. 

Not keeping your asset allocation over a long period of time may decrease your chances of meeting your retirement goals. However, sometimes the market can affect your investment mix. In that case, you may need to consider rebalancing your portfolio or returning your asset allocation to your original target percentages. 

If your portfolio has drifted significantly from your target mix, you will want to rebalance it by selling and buying funds to return to your desired allocation, and perhaps buying assets when their prices are reduced.

3. Pay attention to fees

High fees can take a large percentage of your retirement, especially during volatile markets. You should pay close attention to your total expense ratio, or the annual cost of managing your investments. By looking at your investment expenses and any fees charged to you by your service providers, such as your recordkeeper or advisor, you can find out the total costs associated with your retirement account. It's essential to understand the effect of fees on your long-term investment growth. Consider this: If you invest $10,000 in a fund that grows at 6% annually for 10 years, the presence of even a seemingly small 1% annual fee can significantly diminish your final returns. This 1% fee, charged each year, will compound over time and reduce the overall growth of your investment ($16,289 over 10 years) compared to a scenario without such a fee ($17,908 over 10 years). Therefore, it is crucial to keep the total expense ratio low, generally below 1%, to maximize your retirement savings potential over the long run.

4. Be aware of your plan’s investment menu

Beyond simply minimizing fees and securing your employer match, the quality of the available investment options in your retirement plan is critically important, especially during volatile market periods. Some plan administrators might include or keep their own funds on the investment menu, even if these funds are underperforming or carry high fees. Holding such investments can heighten losses when the market declines and slow down your portfolio's subsequent recovery. This is why it's vital to actively review your plan's specific investment choices and understand where your money is allocated.

5. Taking out loans

Even when you’re meticulously minimizing your investment fees, you may be throwing your hard work away by taking a loan out of your retirement account. 401(k) plans charge about 1% to 2% over the prime rate on loans. While you pay that interest back to yourself, if that interest rate is consistently below your fund’s rate of return, then you’re actually fighting against the tide and missing out on valuable 401(k) gains. Generally, you have up to five years to pay back a loan. However, missing several payments or separating from your employer can make the remaining balance due and payable. If you are unable to pay back the loan, the remaining balance is considered a taxable distribution in the year of the default, and you may owe taxes and  a 10% early distribution penalty if you are under age 59 1/2. 

6. Build overall financial resilience 

If your personal finances are strong, having an adequate emergency fund (usually at least three months of expenses) provides a crucial safety net that can help you cover unexpected costs or periods of reduced income. Additionally, managing any high-interest debt can help with cash flow, for both your immediate needs and for continued 401(k) contributions. 

The bottom line

Market cycles are unavoidable. However, by carefully choosing investment options, refraining from taking out loans, rebalancing your asset mix consistently, and taking advantage of employer matches, you can put yourself in a better position to achieve your retirement goals.