Protecting Your 401(k) From a Stock Market Crash

By Mike Obel | AUG 30, 2023

For most people, using a workplace retirement plan like a 401(k) is the easiest and most effective way to save for retirement. It allows you to get exposure to the stock market and its growth without the need for much investing knowledge. All investing comes with risk, though, and even when you put your money in the stock market through a considered safe 401(k) plan, you can still lose it in a stock market crash. A financial advisor can help you diversify and rebalance your portfolio for market conditions.

Protecting Your 401(k): Adjust and Rebalance Your Portfolio Regularly

The impact of a crash or a bear market on your 401(k) will depend largely on where you’re at in your retirement journey. If you’re young and in the early stages of saving, most of your assets could be in stocks and other equities. If a stock market crash hits, this may cause you to lose a lot of value, since stocks themselves usually see the largest volatility. 

However, that won’t matter as much to a young person as it would someone nearing retirement, since they likely won’t have to withdraw their funds any time soon. The stock market follows a cycle, and historically, well-diversified portfolios can recover over time.

That said, if you’re just a few years away from retiring, a stock market crash could have a huge impact on your retirement. This is especially true if you are still largely invested in equities. When investors get older, they tend to shift asset allocations so that their portfolios are made up mostly of fixed-income assets, ETFs and other safer investments, as well as cash. These are much less impacted by a stock market crash and should limit the effect of a downturn on your retirement assets.

Protecting Your 401(k): Using Target-Date Funds

Target-date funds, or TDFs for short, are financial products specifically designed for retirement plans like a 401(k). They can provide you with some protection from stock market crashes and other fluctuations due to their structure. Essentially, target-date funds automatically adjust your portfolio’s asset allocation over time to fit your stage of life. That’s because they’re built to change as you near your target retirement year, hence their name.

Here’s how they work: you pick a target-date fund corresponding to the year in which you plan to retire. You continuously contribute money to your 401(k) with each paycheck and it’s invested through the target-date fund. The fund will invest your money in a variety of assets, like stocks, bonds and mutual funds. As you get older, the asset allocation becomes more conservative, preparing you for your impending retirement. This means that as you approach retiring, the securities you’re invested in will go from mostly high-risk/high-reward stocks to safer investments like bonds.

Protecting Your 401(k): Don’t Stop Contributing

It can be dispiriting when you see a downturn in your 401(k) value as a result of a broader market decline. That said, don’t let that disappointment lead you to stop contributing altogether. This will only push your retirement savings further into decline, and it may cost you the opportunity to invest in assets at discount prices.

Throughout your career, keep contributing to a 401(k) and other tax-advantaged retirement accounts. As you get older and hopefully have a higher salary, consider increasing the amount you’re saving each paycheck so that you can grow your nest egg faster. Even in a downturn, more principal invested will mean more money for retirement. This will also help you maximize your ability to take advantage of compound interest, which is your best friend when it comes to long-term savings.

Protecting Your 401(k): Don’t Forget Cash

Although it might sound overly simple, having cash on hand is one of the best ways to make sure your portfolio is protected from a stock market crash. Even when you’re younger, having some cash on hand, like in an emergency fund, is a good idea in case there is a truly catastrophic collapse. So not only will these funds protect you from a crash, they can also provide a financial backup if you lose your job or need a car repair.

You should avoid keeping this money in your 401(k) or other retirement accounts for it to serve its purpose as a risk protection. That’s because if you need to withdraw before you turn 59.5, the IRS will hit you with a hefty 10% penalty. The only exception to this is the rule of 55, which allows 401(k) account holders to withdraw penalty-free if they leave their job in or after the year they turn 55. Therefore, it’s more advisable to hold your funds in a savings account, money market account or another liquid account.

Bottom Line

Investing in the stock market always carries risk, including investing via a 401(k). One of those risks is that a stock market crash can tank the value of your portfolio. There are ways to protect yourself, though, such as adjusting your asset allocation, holding cash and continuing to invest. Protecting your 401(k) from a potential stock market crash or an extended bear market is a good planning practice to ensure your assets are maximizing their growth during any economic climate. 

Retirement Planning Tips

• When building an investment portfolio that considers risk, you may want professional help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you don’t have access to a workplace retirement plan, consider getting a retirement account on your own, such as an IRA or a Roth IRA.

Photo credit: iStock.com/oatawa, iStock.com/ismagilov