Protecting Your 401(k) During a Recession

For many people, their workplace 401(k) is their first exposure to investing. And when you start contributing money to your 401(k)—and, if you’re lucky, your employer starts contributing—it can be exciting to see your balance grow. But if you’ve lived through a recession as an investor, you know that account balances also go down.

For someone who is experiencing their first recession, it can be scary and disappointing to watch your retirement balance shrink. Even if you’ve been through it before, it’s natural to wonder whether economic events will harm your ability to retire comfortably and on time.

In this article, we’ll explain what both recessions and 401(k)s are, what’s likely to happen to your 401(k) during a recession and how you can protect it.

Generally speaking, a recession is a period of significant economic decline. While there’s no official definition, experts generally recognize a recession as being two consecutive quarters of a negative gross domestic product (GDP), the value of goods and services produced in a society.[1]

Recessions come about for a variety of reasons, including:[2]

• An overheating economy (meaning one that’s expanding at an unsustainable rate)

• Asset bubbles (similar to what we saw leading up to the 2007–2009 recession)

• Economic shocks (or unexpected negative economic events)

Recessions can have a number of negative impacts on the economy. Because of the reduced economic output, some businesses may be forced to close their doors. Others lay off employees, which leads to increased unemployment. Finally, there’s often a decline in asset prices, including those in your 401(k).

A 401(k) is a type of employer-sponsored retirement plan offered by many private-sector companies. Employees who have access to a 401(k) can defer money from their paychecks into their accounts, which they can then invest for retirement.

The money you contribute to a 401(k) plan is taken from your paycheck pre-tax, meaning it reduces your taxable income for the year. The investments will grow tax-free in your account, and funds will be subject to ordinary income taxes when you withdraw them during retirement.[3]

The IRS currently allows individuals to contribute up to $20,500 per year to their 401(k) plans, with an additional $6,500 allowed for workers 50 and older. Many employers also contribute to their workers’ 401(k) accounts, usually matching an employee’s contribution up to a particular percentage of their salary.[4]

Once you’ve deferred money to your 401(k), you can invest based on a menu provided by your employer. Most employers offer their employees the choice of mutual funds and target-date funds.[5]

Unfortunately, a recession can have a negative effect on asset prices, and therefore, on workers’ 401(k) balances. According to CFRA Research, an investment research firm, the S&P 500 has lost an average of 8.8% of its value during the past four recessions. So if you had a balance of $100,000 before the recession, your balance would fall to roughly $92,000.[6]

Of course, not all recessions behave the same. For example, during the 2007–2009 recession, the stock market fell by roughly 50%. The effect on your 401(k) would have been far more noticeable during that time.[7]

One thing worth noting is that by the time something has been declared a recession, the economy has often been on a downward trend for about six months. As a result, you’ve probably been feeling losses in your 401(k) before you knew you were in a recession. And since stock prices are forward-looking, you’ll probably see your 401(k) balance begin to bounce back before the recession has officially ended.[8]

While any sort of economic downturn can be scary, especially when your retirement savings are at stake, they are only temporary. U.S. stock markets have recovered from every downturn in history. In fact, they have actually recovered quite quickly.

“Over the long-term, investors have not only recovered their losses, but have seen the value of their investments grow. Indeed, the periods following recessions have often been rewarding ones for investors,” according to Capital Group, an investment management organization.[9]

So what does this mean, exactly? Even in a recession where your 401(k) balance loses more than 20% of its value, you can generally expect to recover all those losses in less than two years.

When you see your 401(k) balance declining or hear on the news a recession is coming, it’s natural to wonder what you should be doing to protect your retirement savings. You might be surprised to learn the answer: nothing. At least, nothing different from what you’ve been doing.

“That’ll take some grit because it’s certainly not easy to see a drop in your life savings,” says Eric Phillips, a Chartered Financial Analyst and senior director of partnerships and strategic insights at 401(k) provider Human Interest. “Money can be really emotional, and it’s hard to manage the fear, anxiety, and other emotions that have you worried about your financial picture today and tomorrow.”

If you stop contributing to your retirement account (or worse, sell off your investments), you’ll be doing so when prices have dropped. As a result, you won’t see the benefit of your stocks rising in value as the market bounces back.

“Ideally, you’re invested with a long-term strategy in mind and, when the market returns, you’ll see the gains and growth,” Phillips says. “To get a chance at those gains, you’ll need to stay invested. If you pull your money out, you could miss out entirely.”

To make the best of a recession, continue contributing to your 401(k) plan. Make sure you have a well-diversified portfolio that includes an appropriate mix of stocks and bonds. If you aren’t sure how to accomplish this, a target-date fund is a great place to start.

What happens to my 401(k) if the market crashes?

A stock market crash is a significant and sudden decline in stock prices. Unfortunately, a stock market crash is likely to result in major declines in your 401(k) account balance.

How can I avoid losing money from my 401(k)?

The best way to avoid losing money in your 401(k)—especially during a recession—is to avoid selling off investments. When you sell an investment that’s lost value, you lock in your losses. Since the stock market has recovered from every recession in history, you’re almost certain to see your investments bounce back if you hold onto them long enough.

Where is the safest place to put my retirement money?

Every investment requires some level of risk, and those with the smallest amount of risk generally also have the lowest returns. In general, experts recommend putting your retirement funds into a well-diversified portfolio that includes a ratio of stocks and bonds that’s appropriate for your time horizon. Many people opt for target-date funds for their retirement money since they adjust their asset allocation as you get closer to retirement.