Here's how to recession-proof your 401(k)

·Senior Columnist
·8 min read

Can your 401(k) weather a recession? Economists are warning one is on the horizon.

If you’re anything like me, you probably haven’t looked at your 401(k) balance in a while — but for good reason. I know it won’t be a pretty sight, and I’m comfortable with how I’ve divvied up the investments.

In other words, the percentage I have set in stocks is a level I can live with knowing I don’t need to tap the funds for years.

I understand equities come with a higher level of risk. However, even with the swoons — and I have already rolled through several — stocks have outperformed other types of investments over time. But I’m patient.

There’s no doubt this year has been an angst-filled one for retirement savers. The S&P 500 fell 20.58%, the Dow Jones Industrial Average dropped close to 15.31% and the Nasdaq Composite collapsed nearly 30%.

“Whether you are just getting started, or are almost there, watching retirement plan values dip as news of a recession crosses the screen is enough to make even the fiercest investor queasy,” Liz Davidson, founder of Financial Finesse, a provider of workplace financial wellness coaching programs, told Yahoo Money.

Display of Stock market quotes. Stock exchange board. Led digital display effect. Vector illustration.
Display of Stock market quotes. Stock exchange board. Led digital display effect. Vector illustration.

Алексей Белозерский via Getty Images

Most of us with 401(k) plans are heavily invested in stocks. Last year, roughly two-thirds of all 401(k) funds managed by the mutual fund company Vanguard was held in stocks, according to Vanguard’s new report.

That’s why I know most of you are feeling worried. Of course, how concerned you are may depend on how many years you have before you will need to start tapping these tax-deferred retirement funds. If you aren’t selling your stocks, you haven’t lost anything yet.

“As an investor, you can expect moments like this, but historically they do not last forever,” Davidson said.

Retirees are the ones who will feel the pain if they need to take a required minimum distribution this year. That's the amount you must withdraw from a tax-deferred retirement plan and pay income taxes on after you reach age 72 (or 70.5 if you were born before July 1, 1949). After that, you typically must take an annual distribution by December 31.

If you’re decades away, you have time for this bear market to recover from its recent losses. Within the last five years, there have been three bear or near-bear markets. In 2018, markets toyed with a 20% decline but bounced up just a hair away from a bear market moniker. The 34% pandemic decline in March 2020 was a blink, but people did panic. I even checked in with my financial advisor for some hand holding.

However, there’s another potential hurdle this time around which is tricky, With inflation still hovering at the highest it has been in four decades, and The Federal Reserve hiking short-term interest rates, a possible recession is something to pay attention to now.

That means it’s a good time to reassess your retirement accounts.

Here are some smart strategies for managing your 401(k) during a recession and, to be honest, in good times, too.

Take stock of your savings outside of retirement accounts

“One of the first things you can do to recession-proof your 401(k) is to make sure you have enough set aside in a bank account for emergencies, like a job loss,” Candace Lee, a certified financial planner with Glassman Wealth Services in Vienna, Va., told Yahoo Money. “The last thing you’ll want to do is take an unnecessary 401(k) withdrawal as these are generally subject to a 10% early withdrawal penalty.”

Keep cool and review your asset allocation for diversification

Now is the perfect time to consider your risk tolerance.

Gold nest eggs with pink, green, and blue nest eggs reflect diversified investment success and growth
“Asset allocation, diversification and periodic rebalancing are just about the most certain protection strategies for your investments," said Rob Williams, managing director of financial planning, retirement income and wealth management at Charles Schwab (Photo credit: Getty Creative)

“Asset allocation, diversification and periodic rebalancing are just about the most certain protection strategies for your investments,” Rob Williams, managing director of financial planning, retirement income and wealth management at Charles Schwab, told Yahoo Money. “Of course, developing a long-term strategic asset allocation plan is key to your ability to retire. But sticking to that plan regardless of market swings or recession periods is even more important.”

Your age is a factor here.

“If you have 10 years or more before you're ready to start taking distributions, you’re probably in a position to ride out the recession and allow time for your stocks to rebound,” Lazetta Braxton, a Certified Financial Planner and co-founder of 2050 Wealth Partners, a fee-only financial planning and wealth management firm, told Yahoo Money.

One simple equation many financial planners recommend is the percentage of retirement money you have invested in equities should be 110 minus your age.

Investing in the stock market does come with a dollop of risk. That said, over time you’re generally paid back with higher returns than if you had parked the retirement savings in plain vanilla certificates of deposit, money market accounts, and bonds.

When you diversify your holdings and balance your investments typically between equities, bonds, and cash securities, it creates ballast. When one asset class takes a hit, the other is usually on the rise or holding steady.

Review the fees you pay

Fees can chip away at your investments regardless of the market gyrations. On average, 401(k) fees can reduce investment returns by 1% to 2% a year, which can add up to thousands of dollars over the years. One way I cut the fees charged by fund companies on my retirement accounts is to invest in a handful of low-cost stock and bond index funds.

In 2021, the average expense ratio of actively managed equity mutual funds was 0.68%, according to the Investment Company Institute. Index equity mutual fund expense ratios by comparison, were 0.06% in 2021. Last year, expense ratios of index equity ETFs were 0.16%.

Average bond mutual fund expense ratios were 0.39%. Expense ratios of index bond ETFs were 0.12% in 2021.

Consider a target-date fund

I like the simplicity of target-date retirement funds, which increasingly 401(k) plans are offering.

Even if your 401(k) has very limited investment options, or if you don’t know what to choose, a target-date fund generally will work just fine,” Lee said. “One of the reasons I like a target-date fund is that it automatically rebalances by adjusting the level of stocks and bonds in your portfolio as you near retirement.”

With a target-date retirement fund, you select the year you’d like to retire and buy a mutual fund with that year in its name. The fund manager then splits up your investment between stocks and bonds, changing that division to a more conservative blend as the target date looms. Ninety-five percent of target-date mutual funds are funds of funds—mutual funds that invest in other mutual funds.

There are drawbacks to some of these target-date funds. Fact is, they aren’t necessarily cheap, and they can lull you into inertia to never look at how your assets are balanced.

Expense ratios of target-date mutual funds averaged 0.33% in 2021, according to the Investment Company Institute. But target-date funds that invest in index funds are typically lower. Vanguard Target Retirement 2045 Fund, for example, has a fee of .08%.

It is down 18% this year (but not as much as the S&P).

“For most 401(k) savers who are investing in target-date funds, no matter their age, the best approach is to stay the course through this period of market volatility,” Williams said. “Target-date funds are designed for the long term, just like your 401(k) is intended.”

That said, there is an option if you're uneasy.

“If the level of volatility associated with your current target date is too much, you may be able to reduce future volatility by reallocating to a TDF with a closer target date,” Davidson said.

Now is not the time to get spooked into cutting back on your contributions to your retirement account. (Photo credit: Getty Creative)
Now is not the time to get spooked into cutting back on your contributions to your retirement account. (Photo credit: Getty Creative)

Keep making contributions

Now is not the time to get spooked into cutting back on your contributions to your retirement account. The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan is $20,500 in 2022.

“For most investors, remaining disciplined by continuing to contribute a portion of each paycheck to your 401(k) is the best strategy,” Lee said. “You are paying yourself first. Part of remaining disciplined also includes rebalancing, and if you can, set up automatic rebalancing. When we see a market downturn, the plan will automatically buy low.”

Investing in your 401(k) during low market times offsets the periods when you contributed when the market was high over the last decade.

“In fact, you may want to increase contributions if you have the cash flow,” Braxton said.

Seek out professional help

“If you’re managing your account on your own and choosing investments from the menu your employer offers, now is a great time to take advantage of advice if it’s available to you,” Williams said. “These advice services are usually free or low cost.”

Moreover, many financial advisers take middle-income clients and have reasonable fees. Interview a few. There are searchable databases at sites of the National Association of Personal Financial Advisors, the Financial Planning Association, XY Planning Network (XYPN) and the Certified Financial Planner Board of Standards.

Find one you like and then ask the questions to help you understand and give you the sense of control of your retirement savings if that recession does come to pass.

Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon

Click here for the latest personal finance news to help you with investing, paying off debt, buying a home, retirement, and more

Read the latest financial and business news from Yahoo Finance

Download the Yahoo Finance app for Apple or Android

Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, LinkedIn, and YouTube