If your heart started racing when you received your most recent quarterly 401(k) statement, detailing more loss than you bargained for, you’re not alone. Many contributing employees — especially those nearing retirement age — are feeling the retirement fund pinch lately, facing some very real fears about surging inflation and a possible recession as stocks tumble. The resounding question — are portfolios that once swelled during the long bull market doomed?
“401(k) accounts have taken a beating this year along with most other investment accounts,” noted Joseph Marchese, founder and president of Financial Planning Concepts of America in Bloomfield. “If you aren’t planning to retire for five years or more, it doesn’t mean much — your investments have plenty of time to recover. It still hurts when you open any of your statements … but as long as you contribute money from each paycheck into your 401(k), you are buying a lot more shares of your investments than you were at the beginning of the year.”
According to Marchese — a certified financial planner practitioner who leads one of the few independent Registered Investment Advisory firms in the area that has a fiduciary obligation to its clients — stocks and bonds are basically on sale, and you’re buying at the discounted price.
“If you were planning to retire this year, you may be feeling a bit anxious,” Marchese continued. “Unfortunately, this may be the case even if you’ve allocated a reasonable portion of your 401(k) into bonds and other fixed income investments. That’s because many bonds and bond funds have also suffered double digit losses this year. Cash and money market funds have been one of the few places to avoid these losses, but many investors have been reluctant to keep money in these low yielding investments because inflation has been increasing so rapidly.”
So what should you do if your portfolio is down 10%, 15%, even 20%? Marchese said you should assess your risk tolerance before you panic.
“You’ve probably heard this before, but you should have had your investment accounts, including your 401(k), invested in a way that let you sleep at night,” the expert noted. “While no risk tolerance measure is perfect, you should have a sense of how much money you can lose before you start really worrying. Generally, your risk tolerance becomes lower the closer you get to retirement, but this depends on the sources and stability of income you will depend on in retirement.”
Marchese provided an example: “If you and your spouse have pensions and social security that will bring in $160,000 a year, and your expenses are $100,000 a year, you have a $60,000 cushion and can handle more risk in your investment portfolio. If the opposite is true, and you need to draw $60,000 a year from your investment portfolio [after taxes], you’ll need at least $1,500,000 to draw that $60,000 from. If you had that $1,500,000 at the beginning of the year, you likely have less than that now, and your long-term financial health will be compromised if you have to withdraw from a decreasing asset.”
Marchese suggested that investors use the common 4% rule as a withdrawal rate to figure out how much you can lose in your 401k and other investment accounts and still cover your withdrawal.
“If you had $2,000,000, you could lose $500,000, or 25%, and still meet your retirement income need (using the above example) so your investment portfolio ought to be allocated in a way that avoids very large losses,” he said. “There are no guarantees that a given allocation will perform as expected, but it gives you more than a fighting chance to enjoy your golden years if you know how much income you need, and then you make sure your investment allocation has a good chance of providing that.”
Marchese advised leaving a little room to spare just in case everything goes against you — as it seems the financial markets are doing now.
“It’s almost a perfect storm with stocks and bonds both dropping like a rock at the same time the Federal Reserve is dramatically raising interest rates because inflation is getting out of control,” he said. “This runs the risk of throwing the economy into a recession. If all this is happening close to the time you’re retiring, you’re going to wish you had a little extra cushion in case that perfect storm materializes. That’s a lot of balls in the air to be juggling just as you’re planning to give up your paycheck, but it’s manageable if you plan well.”
Kevin Chau, senior vice president and certified financial planner with Merrill Wealth Management, echoed Marchese’s sentiments.
“Given the recent market volatility, we understand that investors have questions about their 401(K) plans,” Chau added. “It is important to keep in mind that your 401(K) is a retirement vehicle, meant for a long-term strategy.”
According to Chau, who has 27 years of experience in the industry and was named to the Forbes Best-in-State Wealth Advisors list for three years running, that strategy should consider market ups and downs.
“As you approach retirement, your investment time horizon decreases,” Chau said. “It’s important to build a diversified portfolio from the start. Diversification helps mitigate risks, mutes the impact of volatility, and provides guidance for rebalancing. A well-allocated portfolio helps the investor to participate in the recovery. The asset mix depends on factors such as your risk tolerance and time horizon and would likely include equities, fixed income, and cash or cash equivalents.”
Chau said that younger investors should analyze their asset allocation on a quarterly basis — not daily.
“Younger investors have a longer time horizon, and market volatility can be an opportunity to dollar cost average their contributions,” Chau said, detailing a strategy in which the investor buys a fixed dollar amount of shares on a regular basis over time, regardless of the market price.
“Instead of considering market timing in investment decisions, we prefer to rely on a disciplined approach to asset allocation based on the client’s goals,” Chau concluded. “It would be a good idea to revisit your asset allocation on a quarterly, rather than on a daily, basis — the last thing you want to do is make an emotional decision based on fear of short-term volatility.”
One thing Marchese recommended NOT doing is moving your money to cash or money market funds if you have to sell investments at a big loss.
“You are likely to miss the rebound that will eventually occur,” he said. “It’s understandably hard to remain calm when the economy and financial markets are tanking, but selling after big losses locks in those losses with no chance to recover.”
Rely on any pre-planning you might have already done and consider working another year or two if necessary, Marchese said.
“If you are retiring in the next year or two, you should have begun planning for how best to replace your paycheck a few years ago,” Marchese concluded. “This planning should have included estimating your income needs, figuring out whether your investment accounts would support those needs after accounting for social security and any pension income, and re-allocating your investment accounts, if necessary, to protect the first few years of retirement income in case the financial markets didn’t cooperate with your retirement plans. If you didn’t plan ahead and find yourself unable to meet your income needs, I know these suggestions won’t be met with enthusiasm, but consider working a year or two longer if you have the choice, or consider limiting some of your early spending plans and maybe delaying any travel plans or second-home purchases.”