If you have contributed to your employer’s 401(k) plan, it is normal to be anxious about the plan’s performance. As with any investments, there are dangers associated with saving for the future. Even though many 401(k) plans are structured to protect against big losses, your account balance might decline dramatically.
To increase your 401(k) balance, you must be aware of potential hazards and take action to reduce them. Here are the factors that might contribute to a fall in your 401(k) balance and what you can do to prevent losses.
You can incur a 401(k) loss if you:
- Cash out your investments during a market slump.
- Have a significant investment in business shares.
- You cannot repay your 401(k) loan.
- Leave your employment before acquiring the business match.
To increase your 401(k) balance, you must be aware of potential hazards and take action to reduce them. Here is a look at how money might be lost in a 401(k), as well as what you can do to prevent losses.
Changing 401(k) Investments to Cash
You may observe variations if you check your account balance regularly, particularly when the economy reacts to changes. According to Clayton Quamme, a certified financial planner with AP Wealth Management in Augusta, Georgia, people become concerned when account balances begin to decline during market downturns. They begin to panic and convert their funds to cash for protection.
Although it may seem prudent to withdraw assets from an investment and retain them in cash, doing so might result in a financial loss. When you sell during a recession, you transform a momentary loss into a permanent one, explains Quamme. As the market rebounds, your account balance will increase if you remain invested.
Having Excessive Company Stock
Some organizations provide direct investing options that permit some employees to purchase company shares through the 401(k) plan. The agreements may involve a business match or other incentives to entice employees to buy the stock. According to Jon Lawton, managing partner and CFP at OpenAir Advisers in the Dallas-Fort Worth region, these incentives might be a wonderful way to maximize employer benefits.
In addition, it is prudent to examine your total financial strategy and carefully choose how much business stock you desire. As a general rule, approaching retirees should never hold more than 5 percent of any one stock in their retirement plan, says Lawton. If you have more, you run the danger of incurring greater losses. Suppose that 50%, 80%, or even 100% of your 401(k) is invested in business shares. In addition to market risk, there is also a company-specific risk, according to Lawton. You may incur a significant loss if the firm performs poorly or declares bankruptcy. Owning business stock as an element of your entire retirement plan may be helpful and profitable if it corresponds with your overall risk, adds Lawton.
Taking Out a 401(k) Loan
If you require access to your 401(k) balance before retirement, you can take an early withdrawal or a 401(k) loan. Withdrawals from a 401(k) before age 59 1/2 typically incur a 10% early withdrawal penalty and income tax. Alternatively, you might borrow money from your 401(k) without incurring penalties or taxes, provided you repay the loan with interest.
However, a 401(k) loan may expose you to financial danger, particularly if you quit your employment before repaying the debt. Katharine Earhart, a partner and co-founder of Fairlight Advisors in San Francisco, says, It’s likely that you’ll need to repay the loan quickly. Should you not be able to repay the loan, your previous employer may consider it a distribution. For borrowers under age 59.5, early withdrawal penalties and taxes will apply, and those funds will not accrue interest or increase over time.
Leaving Before Completely Invested
Before you are permitted to keep all of the assets in your 401(k) plan, some firms have specific conditions that must be completed. Your contributions are always entirely yours. There may be a waiting period before you’re eligible for a 401(k) match from your employer. “The majority of corporations demand you to remain for three, five, or even seven years before receiving a corporate match,” Lawton explains. You may forfeit the employer contribution if you quit before you are completely vested in your 401(k).
Losses Can Be Avoided Through Risk Management
To avoid emotionally charged actions that might result in a loss, it can be advantageous to have an investing strategy in place. This often requires a conversation with a financial advisor and a review of your portfolio to ensure that your contributions are spread throughout various investment kinds. Earhart explains that if you have a diversified portfolio of stocks and fixed income, your risk is distributed across many asset classes. A big proportion of your savings in stocks might raise your risk, particularly if you are nearing retirement age.
Some employers enroll new hires in a 401(k) plan automatically. Then, the employees are automatically given a portfolio depending on their age and desired retirement date. If this occurs, it might still be good to review the assets and determine what level of risk you are comfortable with. The optimal technique is to select an asset mix depending on your objectives and emotional capacity to remain involved, explains Quamme. Then adhere to it.