President Trump’s first 100 days in office sparked concerns over U.S. tariffs, upended global trade and caused significant volatility in financial markets.
However, in the last week or so, major stock indexes rose and the dollar gained against the euro and other currencies while gold fell as the White House signaled a willingness to de-escalate its trade war with China and China signaled it was open to trade talks.
U.S. Treasury Secretary Scott Bessent said that high tariffs between the United States and China are not sustainable, while U.S. President Donald Trump signaled he was open to easing trade tensions between the world's two largest economies.
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That's good news, but until global tensions ease, the market will undoubtedly remain in flux. While experts agree you shouldn't panic, you still might be considering tapping into your 401(k). Here's why that might not be the best move in the long-run.
Will my 401(k) decrease in value?
It’s perfectly human to feel nervous in tumultuous time. After all, you want to preserve everything you have worked so hard for. The bad new is that it is very likely the value of your 401(k) investments will decrease (or increase) due to market volatility. The good news is that experts across the board agree that anyone with a retirement account, regardless of where you are in life, should remain calm. This includes not making unnecessary withdrawals from your 401(k).
Acting emotionally can lead to making poor financial decisions. This isn’t to say you shouldn't do anything. Now may be a good time to take a look at your portfolio and see what can be done to soften the blow.
Ben Bakkum, Sr. Investment Strategist at Betterment at Work, says that pausing your 401(k) contributions may also be counterproductive. “Pausing on your 401(k) contributions now can mean missing out on compounding and dollar-cost averaging advantages. It’s important to remember that the relationship between risk and return is fundamental to investing — this recent market drop reflects the risk investors are compensated for bearing over time.”
Keep your perspective; downturns are normal
Historically, financial markets have seen a significant pullback at some point while still delivering positive returns over a full year. Case in point, as outlined by Schwab — in 2018, the S&P 500 saw a market correction of more than 10% in the first quarter of the year and again in the fourth quarter, followed by a rebound of more than 13% in the first quarter of 2019. The tumble in the first quarter of 2020 was followed by a positive return of 18% for the whole year and a gain of more than 100% in less than two years.
Aaron Cirksena, founder and CEO of MDRN Capital, agrees. “Panic is the worst possible strategy. Volatility is part of investing, and we’ve been here before. Staying calm, sticking to your plan, and avoiding rash decisions almost always leads to better outcomes.”
How to protect your 401(k) during a market downturn
While it’s not always the best course of action to withdraw money from your 401(k), now may be a good time to adjust your investment mix if you feel the market volatility is too much to handle.
"In the face of uncertainty, maintaining a long-term investment perspective is crucial, says Bakkum. “Diversification remains essential, as evidenced by the recent performance of European stocks, which haven’t performed quite as poorly as U.S. stocks. Bonds, in particular, have so far provided a nice buffer in portfolios, demonstrating the prudence of holding allocations across asset classes."
Vanguard research shows that balancing methods should not be undertaken too frequently or too infrequently. For many investors, an annual rebalance of your investments is optimal, even in light of the current market situation. Reach out to your account manager at work or a financial advisor for advice if you're not sure how to proceed.
Disadvantages of early 401(k) withdrawals
Right now, you might be tempted to make an early withdrawal from your 401(k). If you can, you should avoid doing so for a number of reasons.
- Withdrawals are taxed. Even if the withdrawal is covered by an exception, all early withdrawals from your 401(k) are taxed as standard income. The IRS typically withholds 20% of an early withdrawal to cover taxes. So, if you withdrew $10,000, you might only receive $7,000 after the 20% IRS tax withholding and a 10% penalty.
- Less money in retirement. An early 401(k) withdrawal means missing out on long-term returns and potential investment appreciation. Morningstar Direct reports that since early 1926, the stock market’s average returns have been around 10% a year for large-cap stocks and about 11.5% annually for small-caps. So, if you withdrew $10,000 from your 401(k) and were about 30 years away from retirement, you could be giving up nearly $264,000 in total returns.
- IRS penalty. If you take an early withdrawal of $10,000 from your 401(k), the IRS could hit you with a 10% penalty on the withdrawal.
Cirksena goes on to say that loans and withdrawals come with tax consequences, lost growth, and in some cases, penalties. “If you’re facing a true emergency, talk to a financial advisor about all your options before tapping into your future.”
Alternatives to a 401(k) withdrawal
Since drawing from your 401(k) can hurt your retirement savings — both in missed market return and reduced principal — you should explore other ways to access cash when you're strapped.
Draw on your home’s equity
A home equity line of credit (HELOC) can help cover your expenses or consolidate debt, often at a better interest rate than a loan. Borrowing against your home’s value gives you the time to get through a financial rough patch and repay what you borrowed when you’re more financially stable — and the markets improve.
Borrow from your 401(k)
Of course, you could take out a 401(k) loan, which doesn’t count as a withdrawal. With this type of loan, you essentially lend money to yourself and pay it back over time through payroll deductions. You can access the funds without paying income tax or being subject to the 10% penalty. Just keep in mind that a 401(k) loan must be repaid within a certain time, typically five years. If not repaid within that time period, you could be hit with an early withdrawal penalty.
Try a Roth IRA conversion
You might want to consider converting your 401(k) into a Roth IRA, which lets you take withdrawals on contributions, not earnings, at any time without penalty. But keep in mind that the conversion is taxed, and you will need to pay taxes on the amount converted. However, once the money is in the Roth IRA, it can grow tax-free. Qualified distributions are also tax-free.
Tap into your emergency fund
An emergency fund can help you manage unexpected expenses without dipping into your 401(k) or other retirement accounts. Ideally, it shouldn’t be touched unless there is an emergency (thus the name). It’s also recommended to have about three to six month’s worth of living expenses in the account to ensure the money is there when you need it most. Borrowing from your emergency fund shouldn’t be your first choice, but on the upside, it will keep your retirement savings intact.
Bottom line
Most financial experts agree that trying to time the market is one of the biggest mistakes you can make. It might feel right in the short term (like during chaos in the markets and the unknown consequences of tarriffs), but you may regret it down the road. That’s because the market will very likely rebound. In fact, 78% of the stock market’s best days occur either in a downturn or within the first two months of recovery, according to Hartford Funds.
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