What You Can Do with Your 401(k) During a Recession

The first two decades of the new millennium saw two historic economic downturns in the form of the Great Recession and the recession caused by the COVID-19 pandemic. While these have been world-changing events, recessions are actually more common than you might think. In fact, economists see them as part of the natural economic ebb and flow.

Still, a downturn affects your finances and can influence the way you think about the future. For example, you may be wondering what to do with your 401(k) during a recession. That's why it's useful to review what options you have, so you can make informed decisions about managing your money.

Markets and retirement accounts

It helps to understand the effect market volatility has on your retirement accounts, such as a 401(k), Roth IRA or traditional IRA. The money you put into these accounts gets invested into stocks. This means that when the stock market drops, so does the value of your investments.

However, the opposite is also true. When the stock market recovers, the value of your investments will increase—and although watching the day-to-day updates can feel harrowing, the reality is that the market does adjust course after a recession.

Staying the course

One of the biggest missteps you can make is to withdraw funds from your retirement accounts in a panic. The stock market goes through natural ups and downs, so it's best not to make knee-jerk decisions based on the events of a single day or even a whole quarter.

In protracted periods of low returns, such as a recession, you may wonder whether it's time to put all your money in other investments. If you're still several decades away from retirement, it might make sense to leave your retirement accounts as they are. In time, the economy will bounce back, and you'll likely achieve solid returns to see you through your golden years.

Don't withdraw funds for short-term needs

If your income takes a hit during a recession, you may feel the urge to withdraw money from a retirement account so you have extra cash on hand. But doing this not only means you'll have less money to earn gains on when the economy recovers—it could also mean you may owe withdrawal penalties.

One alternative is to leave your retirement savings as they are and trim your budget as much as possible to free up some money each month. Barring that, you might ask a relative for a short-term loan or take on a side job to earn extra income. Establishing an emergency fund—ideally with 3 to 6 months of expenses—during more prosperous times can help you weather downturns without taking away from your retirement savings.

Keep contributing

If you have a 401(k) through your employer and are automatically contributing each month, keep adding to that account, especially if your company matches your monthly contribution. While your portfolio may not grow the way you hope during the recession, you'll be glad you kept investing once the economy bounces back.

It's important to remember that recessions end, and the market fluctuates over time. Know that if you're many years away from retirement, you'll be glad you kept adding to your 401(k) when you had the opportunity.

The importance of diversification

If you haven't done much planning aside from enrolling in a 401(k) or IRA, a recession is a good time to think about other steps you can take to build your nest egg for retirement. There are a number of different savings and investment options out there in addition to stocks. You can open a certificate of deposit, or CD, or buy government bonds. You might also consider purchasing real estate you can turn into a rental property.

It's wise to explore options beside stocks—typically, having a balanced portfolio means spreading your risk across several different categories. Stocks and other high-risk investments, such as venture capital or investing in emerging markets, can yield high returns. Keep in mind that riskier investments can also yield higher losses.

You'll probably want some amount of risk in your portfolio, but how much depends on your needs and on your level of comfort. If you're more risk-averse, lower-risk options like bonds and CDs may make sense. There are also medium-risk investments like mutual funds, real estate and certain types of stocks and bonds. Diversifying the risk levels of your investments can help make large losses less likely so you avoid coming up short in retirement.

Ask for help

If you're not sure what to do with your 401(k) during a recession, you can always talk with a financial professional who can help you decide the next best steps for your finances. They'll be able to answer any questions you have about your current investments and help you decide how best to diversify and balance your portfolio.