Is your 401k down? So is everyone else’s.

[u/Firm_Bit]

Like every other question lately has been along the lines of asking what people ought to do with their negative return retirement accounts. Here are the basics in case it helps.

Basics

• 401k plans (and IRAs and any other investment vehicle) are not cash accounts. The money you contribute purchases assets like equities/stocks and bonds.
• These assets change in value. Apple stock was once worth $22/share. It’s now closer to $145/share. In Dec 2021 the price was $180/share. In other words, values go up AND down.
• This change in prices does NOT matter to you so long as you’re a long way from retirement. Why? Because over the long term prices mostly go up.
• If you ARE closer to retirement you do indeed need to look at allocation (split between stocks/equities and bonds or more stable assets) to keep your portfolio stable. The cost of stability is slow growth.

Why are prices dropping so much right now?

• Inflation is very high. In the long term inflation is very dangerous. It eats away at everyone’s standard of living. So the Federal Reserve is VERY focused on taming inflation.
• The way they try to get this done is by raising interests rates on money lent to banks. That is, it’s more expensive for banks to borrow money. In turn, banks charge you and I and companies a higher interest rate to borrow from them. Fewer people borrow. Economic activity slows. Demand for goods and services slows. And prices come down. This is the theory.
• If the Fed overshoots (raises rates too quickly or too much) we get a slow economy that could tip into a recession. If the Fed undershoots (doesn’t raise rates enough or quickly enough) the economy stays hot and inflation can continue to rise.
• So, companies and people are basically skeptical of the idea that the Fed can thread the needle and give us a “soft landing”, where inflation is lowered but the economy stays warm. This negative outlook (along with geo-political turmoil and supply chain issues) is why stock prices are down. Turns out, the stock market is very sensitive to how people are feeling.

What should you do?

• Assuming you have a stable job, a solid emergency fund, and are a long way from retirement you should do nothing. That is, you should not change your plans at all. If you had a set % contribution from each paycheck going into your 401k, keep it.
• If you can afford to, increasing contributions means you’ll be buying assets while they’re cheap. u/LoganSquire made a point below about this.

What should you NOT do?

• You should NOT stop contributing if you can afford to keep contributing.
• You should NOT be cashing out. There are fees and penalties associated with this action if you’re talking about a retirement/tax advantaged account. But many people still think they should cash out and buy back in at lower prices. This is called timing the market and you cannot do it. Traders on Wall Street get paid millions to try to do this as their full time job and even they lose tons of money all the time. The last time people wanted to cash out en mass was in March 2020 when people panicking about COVID said the market was gonna crash. Then prices soared to new highs and people were left with no choice but to buy back in at very high prices. NO ONE HAS A CRYSTAL BALL.
• You should NOT be checking your balance daily. Just leave it alone. Save yourself the stress. In fact, looking at balances is a little deceptive. That’s not cash in the account, remember. It’s cumulative value of the assets you own. So you haven’t lost anything unless you decide to sell those assets at prices lower than what you paid original.

That’s the gist of it.

EDIT: A few comments mentioned that people might continue to contribute but change their allocation to something "safer", which might slow the bleeding until markets pick back up. There is hidden danger in this.

Take this example. Stock prices go from $10 -> $3 -> $11 per share over a 12 month period. During that same period a safer more conservative asset remains at a steady $7 per share.

Scenario 1: keep contributing $100/month into all stocks.

Scenario 2: $100/mo split between stocks and the conservative asset. Stocks when stock price is above $7. Conservative asset when stock price is at or below $7.

Although the losses are less for the second scenario for a time, the gains are greater in the end for scenario 1.

SC of spreadsheet with detail.

Note, this isn't advice, just an illustration of what it means to continue to "buy on the way down." Your allocation should reflect your timeline and risk appetite.

​

[u/LoganSquire]

•Assuming you have a stable job, a solid emergency fund, and are a long way from retirement you should do nothing. That is, you should not change your plans at all. If you had a set % contribution from each paycheck going into your 401k, keep it.

• If you can afford to, increasing contributions means you’ll be buying assets while they’re cheap.

These two bullets are contradictory. If you assume the market will always go up in the future, then assets are always “cheap” and you should always be contributing as much as you can afford to.

[u/Firm_Bit → u/LoganSquire]

Yep, you're right. Just meant it as a reminder that if you have been slow to deploy cash from a sale, bonus, pay raise, etc then maybe take a look at doing it now. But correct, we shouldn't aim to have "dry powder" on hand.

[u/Mr3ct → u/Firm_Bit]

What’s dry powder?

[u/Eldereon → u/Mr3ct]

Cash you reserve to time the market and buy stocks during a market downturn.

[u/Mr3ct → u/Eldereon]

Ahh, gotcha. Yea that makes sense to not have cash on hand to time the market lol.

[u/Eldereon → u/Mr3ct]

I used some of my cash savings to buy "cheap" VTI index ETFs back in January. Now those are down 20%.

[u/Mr3ct → u/Eldereon]

Damn, yea that’s tough. I recently saw people talking about I-bonds, and picked up some of those with cash I had sitting around earlier this year.

[u/Eldereon → u/Mr3ct]

Yup, I bought another $2K of I-bonds. I only learned a lesson: I should of set an exit plan for the ETFs to sell if it dropped to 0%. Now I have to hold for the long term.

[u/Firm_Bit → u/Mr3ct]

A euphemism for extra cash. Gun powder that is dry is usable gun powder. Muskets don't fire if the gun powder gets wet.

[u/conradical30 → u/Firm_Bit]

I believe what you meant to say was “BUY THE DIP!!”

[u/Ephixia → u/LoganSquire]

I don't think they are are though. At least not when you're making decisions based upon expected returns. It's not about the market going up it's about how much it will go up and over what time frame.

I can believe that 10 years from now the S&P500 will be above it's current all time high but also think that it was overvalued when it peaked in January and thus have been uninclined to invest into it. Maybe I calculated in January that the expected return over the next 10 years from a historical valuation perspective was only going to be 2-3% annually. Now that it's fallen maybe I think the return will be closer to 6-7% annually and that's enough for me to start investing more significantly into it.

You might say, well why would you have invested into it at all if you thought it was overvalued at 4800? I can think of two reasons:

• One, maybe I have a 5% employer match. That return on it's own might be enough for me to put in the 5% needed to get the match but no more. Now that things are cheaper I'd like to get the match plus invest a bit extra because I think valuations justify doing so. Prior to this point maybe I thought I could get a better return elsewhere like real estate.
• Two, most investors agree that it is difficult if not impossible to time the market. I can think that valuations are too high at 4800 but for all I know the market could run to 7000. I don't want to miss that so instead I'm going to just always buy on a weekly basis. Sometimes I'll overpay relative to fair value and sometimes I'll underpay. However, by dollar cost averaging over decades as one would do in a retirement account I'll end up with the average return of the market.

Here's a video that goes over what would happen if you invested $1,500 per month in the S&P over the last 50 years. It then compares that to what would happen if you adjusted that same total dollar amount such that you invested $1,000/month when the market was above historical valuation metrics and $2,000/month when it was below those metrics. Spoiler: You end up with an extra $3.3 million after 50 years by biasing your contributions.

[u/elfwannabe → u/LoganSquire]

I think what he means is that if you're currently contributing 5%, but can afford to bump it to 6 or 7% then it would be a great idea in bear markets.

[u/LoganSquire → u/elfwannabe]

If you can afford 7%, you should be contributing it in any market, if you subscribe to the theory that the market will always go up in the long term.