What Should I Do With My 401(k)?
Morningstar's experts provide answers to seven of the most frequently asked 401(k) questions today.
|Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.|
Many guides to 401(k) investing--including Morningstar's--provide sound advice. Start investing early so compounding can work its magic. Contribute at least enough to get your full company match. And auto-escalate your contributions, if possible.
But given the extraordinary market events and economic climate we're experiencing today, the standard advice may not fit. Moreover, the CARES Act provides investors with better access to their retirement funds early.
Here are answers to several 401(k)-related questions that investors have during these unique times.
Should I stop contributing to my 401(k)?
There might be many reasons to ask this question. Forgoing contributions for a while could provide some extra cash, for instance. Or not putting new money to work in the market may make some feel as though they have more control over their investments.
But not following your investment plan during a bear market can significantly interfere with wealth accumulation over the long term.
"If you stop contributing to your 401(k) during downturns, you're not buying stocks when they're cheap," explains Karen Wallace, Morningstar's director of education. "Steep stock market downturns are often followed by sharp recoveries, and investors who sit on the sidelines often miss out on these quick inflections." Missing those upturns just makes losses worse.
Wallace observes that missing the best month of return in a given year can pull otherwise positive returns into negative territory. Her recommendation: Keep investing and take on enough risk to meet your long-term goals.
In fact, now may be the best time to increase how much you contribute to your retirement account.
"Volatile markets can engender a feeling of helplessness; even if you aim to be hands-off, your investments are like an innocent bystander amid the chaos," says Morningstar director of personal finance Christine Benz. "One of the best ways to take back control in unsettling times is to increase your savings rate if you can. With so many of our activities constrained these days, conserving cash may be easier than ever, at least for the time being."
Benz suggests calculating how much you may be able to invest rather than spend. Many people anchor on saving 10% of their income, but that may be too little depending on your goal.
"Rather than relying on rules of thumb for something as crucial as your savings rate, I like the idea of creating a custom savings target based on your own situation," she concludes.
Should I change my 401(k) investments?
Investors are usually urged to "stay the course" when market volatility strikes. And in general, that's good advice.
"If you've taken the time to create an asset-allocation plan that makes sense for you given your life stage, you don't want to be monkeying with it in the midst of market volatility," says Benz. "Chances are you will make some changes that you'll later regret."
In particular, young investors with many years until retirement should stick with equities--and may be even add more to their portfolios during times of market duress. Most importantly, young investors shouldn't obsess about short-term losses--thereby confusing risk and volatility.
Volatility refers to price fluctuations in a security or your portfolio over a relatively short period of time--and it's inevitable if you're venturing beyond cash instruments. Risk, on the other hand, is the chance that you won't be able to meet financial goals.
"Through that lens, risk should be the real worry for investors; volatility, not so much," says Benz. "A real risk? Having to move in with your kids because you don't have enough money to live on your own. Volatility? Noise on the evening news, and maybe a frosty cocktail on the night the market drops."
Dig deeper: Risk, Not Volatility, Is the Real Enemy
For those investors nearing retirement, however, now may be a good time to do a portfolio check, if you haven't already. Benz suspects that after a decade-long bull market, some pre-retirees may be a little overly aggressive in terms of their equity stakes. Restoring balance among asset classes makes sense for pre-retirees.
"I think it's a good idea to map out a plan to reduce your equity stake, say by a few percentage points during each of the next several months, rather than making a big radical shift to cash," advises Benz. "Rather than saying, 'I'm going to take this all down in one fell swoop,' get a plan to do so over a period of months rather than trying to do it all in one very large shift."
No matter your life stage, avoid dramatic portfolio moves with large chunks of your portfolio, particularly where uncertainty is high--and therefore the downside of being wrong is also high.
Dig deeper: In Uncertain Times, Humility Is Essential
How can I protect my 401(k) from a recession?
Given the impact the coronavirus pandemic is having on short-term growth, it's only natural to wonder how to shelter your portfolio from any additional market-related shocks. You could tilt your holdings toward higher-quality stock investments, which tend to do better than lower=quality fare in recessionary times. You might also upgrade your bond investments, favoring higher-quality bonds over lower-rated paper. But most investors should avoid wholesale changes, says Benz.
"Taking a hands-off approach to your portfolio in falling markets is often best, but that's only if your investment mix is reasonably positioned given your proximity to your goal," she says. A financial advisor can help you customize your asset allocation and your portfolio plan based on your own situation. You can also use the asset allocations of good-quality target-date funds (like those from Vanguard and the BlackRock LifePath Index series) as a gut check. Benz's model portfolios for retirement savers can also provide some allocation guidance.
Rather than fiddling too much with your plan, think instead about investing in your own earnings power and marketability.
"Shaky markets often coincide with weak economic environments and increases in the unemployment rate, so it only makes sense to be pre-emptive about burnishing your skills," reminds Benz. "That means obtaining additional training, staying current on new products and technologies, or possibly even pursuing an advanced degree."
Should I stop contributing to my 401(k) if my employer has suspended its match?
One of the many benefits of investing in a 401(k) plan is the company match. Many companies will match a certain percentage of your contribution--thereby providing you with "free money" and extra dollars that can compound over time.
In today's tough economy, however, some companies are suspending their 401(k) matches temporarily. In that case, try to increase your contribution so that your overall savings rate stays constant, which allows you to take advantage of market bouncebacks, recommends Wallace.
"Let's say that you contribute 6% of your salary to your 401(k) and your company matches the first 6% of contributions at $0.50 on the dollar," she illustrates. "In this scenario, your savings rate is 9%, which is closer to the 10%-15% savings rate that most financial planning experts recommend. While your company is suspending its match, if it's possible for you given your personal circumstances, increase your salary deferral percentage to 9%."
And when your company does restore its match, you can decide whether you continue to contribute at your new rate or pull back to your prior level.
"But if you can afford to keep this higher retirement savings rate long term, do it," suggests Wallace. "It will help ensure that you can comfortably afford your lifestyle when you no longer have the desire, or possibly even the ability, to work for income."
Should I take a loan against my 401(k)?
The CARES Act has made it easier for investors to borrow from their 401(k) plans. It allows for larger loan amounts--up to $100,000 from $50,000--for people who need the funds because of coronavirus-related issues. In addition, you can also borrow your entire vested balance rather than only a portion of it. You pay the money back on an agreed-upon monthly payment which includes interest, which is often at reasonable rates.
But should you?
"It's never a great idea to borrow money from a retirement account that is in accumulation mode if you can help it--even if you plan to pay the money back within a certain time frame, this is prime time that your money could be compounding and working for you in the market," argues Wallace.
"Loans from your 401(k) are particularly perilous if you lose your job," she adds. "If that happens, you'll be required to pay the loan back right away, usually in 90 days. If you can't, you'll owe taxes and a 10% penalty, unless you're age 59 and a half or older."
Instead, both Benz and Wallace suggest tapping into other sources--such as taxable accounts and Roth IRAs--before taking a 401(k) loan.
Dig deeper: Where to Turn for Emergency Cash
Should I take a hardship withdrawal from my 401(k)?
Thanks to the CARES Act, people who have suffered coronavirus-related harm can tap into their company retirement plans. The Act eliminates the 10% early withdrawal penalty for people affected by the disease, but it allows for the funds to be paid back over three years and the withdrawal-associated tax burden to be spread over three years as well.
"The big downside is that stocks have tumbled in recent months, so it's arguably a less-than-ideal time to be pulling from long-term assets," says Benz. "While you can pay the money back into the account, you may do so after stocks have already recovered."
And as with 401(k) loans, money that you take out for hardship withdrawals is money that's no longer working for you in the market.
I lost my job. What should I do with my 401(k)?
You typically have three choices for your 401(k) when you leave your current job: leave it with your former employer if allowable, roll it into an IRA, or eventually transfer it to your new employer's retirement plan, if available.
"There are some good reasons to consider leaving your assets within the confines of a former employer's plan," notes Wallace. "Though you will not be able to make additional contributions to your balance if left in a former employer's plan, your money will still enjoy tax-deferred compounding."
A rollover IRA may be a good choice for those whose former employers don't allow them to leave behind their old 401(k)s. On the plus side, says Wallace, you have the freedom to invest the assets in anything you'd like--low-cost index funds, target-date funds, and so on. If you're rolling over the balance, she advises to have your former 401(k) provider make the check payable to the new IRA (or 401(k) provider) and send it directly to them, to avoid taxes and penalties.
"Whatever you do, don't succumb to the temptation to take the lump sum in cash," concludes Wallace, especially if you're young. "You'll miss out on decades of compounded growth."
Dig deeper: What Should I Do with a 401(k) from My Old Job?