401-(k) News and Investing Spring 2022

401-(k) News and Investing Spring 2022

How To Invest in Your 401 (k) During Periods of Volatility

When the stock market volatility becomes extreme it is only human to want to panic due to our natural aversion to losses. Many long-term investors become short term investors by seeking the safety of cash over stocks when they see even short-term losses.

But the best investors are long term investors who maintain an allocation of stocks and understand that stocks are long term investments and treat them as such. In general, a diversified U.S. S&P 500 Equity Fund is more likely to produce positive results the longer the holding period. Yes, in the short term it is easy to lose money in it but when held for ten years or longer its more likely to double in value than lose money. Why, because over the long term the S&P 500 Index tends to rise as corporate earnings grow. Even including downturns, the S&P 500’s average annual return over all 10-year periods from 1937 to 2021 was 10.57%. Overall, the S&P 500 Index is rising 70% of the time and the rest of the time its treading water going nowhere, correcting, or in a Bear market. To get the long term returns of the S&P 500 Index you must be always invested and ride out corrections and down markets – stay the course. Studies have shown that investors that miss the best return days in the market, which occur after a market bottom, experience a significant drop in their long- term results.

In the Great Financial Crisis of 2008-2009, when the S&P 500 Index fell 46%, a Fidelity study of millions of 401-(k) investors found that those who stayed invested in the stock market during the downturn outperformed those who went to the sidelines. “From the fourth quarter of 2008 through the end of 2015, investors who stayed in the markets saw their account balances—which reflected the impact of their investment choices and contributions—grow 147%. That is twice the average 74% return of those who moved out of stocks and into cash during the fourth quarter of 2008 or first quarter of 2009. More than 25% of the investors who sold out of stocks during that downturn never got back into the market—missing all the recovery and gains of the last seven years”.

If you are tempted to move to cash during times of volatility, consider a portfolio strategy that is balanced between equities and bonds, and stay in the strategy for the long term. Take for example, two hypothetical investors—one who stayed-the-course, trimmed his equity allocation from 90% to 20% during the bear markets in 2002 and 2008, and subsequently waited until the headline news gave the all clear signal after the market recovered before rebalancing his stock allocation back to his original level of 90%; and another who stayed the course during the bear markets with a 60/40 allocation of stocks and bonds.

The Stay-the-course 60/40 investor significantly outperformed the investor with the more aggressive 90% allocation to stocks who in a panic trimmed his equity exposure in a correction. Assuming a $100,000 starting portfolio 20 years ago, the Stay-the-course investor with the 60% stock allocation would have averaged a 7.5% return, versus 5.5% for the long-term investor who became a short-term investor.

Instead of heading to the sidelines to cash, 401(k) investors with a long-term investment horizon should take advantage of market volatility by sticking with your planned payroll 401(k) contributions. For example, invest your bi-weekly contributions in a diversified S&P 500 Equity Fund thereby buying more shares at lower prices in a correction. Following every down market is an up market when the accumulated shares you bought at lower prices rise in value as the stock market resumes its long term upward climb. If you invest regularly over months short-term downturns will not have much of an impact on your long-term performance. Moreover, accumulating more shares at lower prices during periods of price weakness could boost your long-term results. If you keep investing through downturns, it will not guarantee gains or that you will never experience a loss, but in the past, it has been a better strategy than market timing for long term investors. In fact, some of the worst times in the U.S. economy turned out to be good time to invest. The best 5-year return in the US stock market began in May 1932—during the Great Depression. The next best 5-year period began in July 1982, during one of the worst recessions in the postwar period. More recently the Great Financial Crisis in 2008-2009 was one of the best times to invest for the long term. Since the S&P 500 sank briefly to 666 on March 6, 2009, the index has delivered a 10-year annualized total return of 17.8 percent.

It is always important to maintain a long-term perspective, but especially when markets are declining. Although stocks rise and fall in the short term, they have tended to reward investors over longer periods of time. It is natural for emotions to rule during periods of volatility. Those investors who can tune out the news and focus on their long-term goals tend to fair better than those who panic sell during times of volatility.

Sources: Bloomberg; Lipper. Stocks are represented by the S&P 500 Index from 2/1970 to 12/31/18 and the IA SBBI U.S. Lrg Cap Index from 1926 to 2/1970. The S&P 500 Index is an unmanaged index that consists of the common stocks of 500 large capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Investopedia S&P 500 period returns. Hypothetical returns based on Fidelity Research study. Past performance is no guarantee of future results. The information provided is for illustrative purposes and is not meant to represent the performance of any particular investment. It is not possible to in an Index.