Using a 401(k) allows you to reap substantial tax benefits for saving for retirement. Depending on how you allocate your investments, your account could lose money in a recession. However, before you run to change your 401(k) portfolio allocation, consider the risks versus the potential higher returns offered by different investments.
According to the Financial Industry Regulatory Authority, every 401(k) must offer at least three investment options for plan participants. These can range from those as conservative as certificates of deposit to mutual funds and even to a brokerage account that allows you to pick individual stocks. According to FINRA, when choosing your allocation, you should consider how long you have until retirement, your risk tolerance and your other retirement assets.
Some types of 401(k) investments, including CDs and money market deposit accounts, are covered by the Federal Deposit Insurance Corporation. This coverage protects up to $250,000 in case the bank that holds the investments goes out of business, including a bank going belly up during a recession. However, no insurance protects investments in stocks, bonds and mutual funds. So, if the market takes a dive during a recession, so will the value of your 401(k) plan.
Risks vs. Rewards
Just because your stock market investments could lose value during a recession doesn't mean you should put your entire 401(k) plan into certificates of deposit or other guaranteed investments. The investments that are covered by FDIC insurance offer lower rates of return than stock market investments over the long term, so taking some risks can result in a substantially larger nest egg by retirement, even though you might lose some money during recessions.
Changing Investment Choices
You can change your 401(k) portfolio allocation to match your desired investment philosophy by contacting the financial institution that manages your 401(k) plan. In addition, as you get older, you can reevaluate how you want your assets allocated. For example, as you approach retirement, you may consider moving more of your assets to less risky investments, because if a recession does come you won't have nearly as long to recover. However, if you're younger, you may be comfortable taking more risks, because over several decades the recessions will likely be overshadowed by bull markets.
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