Nowadays, it is essential to build a diversified 401k plan, especially if you want to have saved money when you retire. After all, this is the safest way to minimize risk and maximize profit. Still, there are some downsides to investing in the financial market. For instance, market crashes can scare even the most experienced investors.
Yet, the thought of losing your entire 401k is even scarier. But can you indeed lose your 401k if the market crashes? What will happen? Well, if you want to know the answer to these questions, then you have come to the right place. In this article, we will shortly explain to you what might happen to your 401k if the market downturns.
What is a 401k Plan?
As you probably already know, a 401k plan is a tax-advantaged retirement account. In general, most employers offer this plan to their employees, so it is company-sponsored. Also, employees can make contributions. Shortly said, they can save and invest money before taxes are taken out.
Typically, there are two types of 401k accounts – traditional 401k and Roth 401k. The main difference between these two retirement accounts is in how they are taxed. For instance, a traditional 401k plan is taxed after the employee withdraws the investment earnings. On the other hand, withdrawals in a Roth 401k plan are tax-free.
Furthermore, employees have the right to choose the investments within their 401k account. The most common options include an assortment of stocks, bonds as well as mutual funds. Of course, the goal is to build a diversified portfolio to minimize the risk. In addition, employees can choose to invest in GICs – guaranteed investment contracts, which are typically issued by insurance companies.
Saving and investing a piece of every paycheck sounds promising. However, it might not be enough. Employees should think about how to maximize the initial investment. For instance, considering your age, the amount you will need to retire, your risk tolerance, and other aspects are crucial before choosing investments.
Yet, even if you have managed to establish a diversified portfolio, monitor its performance successfully as well as rebalance when necessary, there are still other facts that can influence the outcome. For instance, a market crash. What will happen with your 401k if the market crashes?
Can I Lose My 401k If The Market Crashes?
Yes, you can, however, only if you have made bad investment choices. Allow us to explain. Say the stock market crashes. In the first case, your portfolio consists primarily of stocks. Well, in that case, your 401k will most likely crash as well. When the market crashes, the value of shares will go down.
Experienced investors know how to benefit from this situation. As equities will be on sale, investors will start investing in the stock market again; thus, expecting to make a profit when the stock market regains its power.
On the other hand, say your portfolio consists of 50% stocks and 50% bonds. If the stock market crashes, then only half of your 401k will crash. The rest will most likely not be intact. Typically, when the price of stocks goes down, the cost of bonds goes up. However, historically speaking, the stock market has shown to rise back up after a crash quickly. So, you will have to be extremely careful with what you do. If you want to know are bonds safer than stocks, click here.
The main thing you should do is to diversify your investments to mitigate risk. Invest in low-fee funds, high-yield bonds, and stocks. Further, as all investments come with risks, don’t forget to always do your own due diligence before investing.