Updated: Dec 17, 2018
On Tuesday, December 4, 2018, the Dow Jones crashed 799 points lower on the day.
The question we started asking was what 401k investors (and all retirement plan investors for that matter) should do when the market crashes. We agreed on one common theme: Doing nothing when the market melts down is the wrong answer (or at least it's not the right answer).
At the same time, people who have a 401k are for the most part, long-term, buy-and-hold investors. But this style of investing shouldn't mean someone doesn't follow or choose their investments strategically.
After making a list of potential actions to take when the market crashes and editing to remove the unrealistic steps, here's our take on what to do in this scenario:
Know your level of risk. If you have high-risk investments, your portfolio will suffer more on down days. On the flip side, it will likely do better on up days in the market. We call this Delta risk or Beta Weighted Delta risk. If your overall portfolio has a Delta of 50, then your account will go up or down $50 with every 1-point move in the S&P 500. The S&P was down about 80 points on December 4, so a portfolio with a Delta of 50 would have been down approximately $4000. A portfolio with Delta of 100 would have been down $8000 so you get the point - know how much risk you're taking. Once you know how much risk you're taking, either change this risk up or down or leave it the same, based on what you feel most comfortable with. A typical retirement portfolio that we manage would have a Delta of 25 or a standard deviation of around 6 if you want to measure risk that way (Delta is better in our view). If you or your advisor don't know how to calculate Delta, give us a call and we'll do it for you.
Consider buying more. If there's a fund or ETF you've been wanting to buy but you've felt like the market was too high, this is your time. Typically in a 401k, you'll allocate a certain percentage of your overall total to each investment. You might allocate 5% to a new holding or add 5% to an existing one if you have available cash. Buying on lows is a smart strategy that surprisingly, very few investors have the stomach for. Benjamin Graham, legendary value investor was famous for saying that your risk actually goes down as the market goes down. Look at it this way and you'll be taking less risk as you buy more on a crashing market. Counter-intuitive, for sure, but a solid investing strategy.
Check your cash reserves. Having a cash reserve in any 401k plan is a smart investing strategy. 25% in cash or a risk free treasury bond is a safe place to start. If you are fully invested in a crashing market, your portfolio will suffer and it will suffer a lot more than you think. It's a good idea to check cash reserves on a regular basis because your monthly contributions to a 401k are likely getting automatically invested, which will lower your cash percentage. Setting a cash target and keeping it that way is a solid 401k strategy.
Selling will be selling at the close. Most 401k plans have a menu full of mutual funds. If you wake up in the morning and check your account, only to see it down thousands of dollars, you may decide to sell. Keep in mind your mutual fund sells won't be filled until the end of the day. This means you may have hundreds of points, and thousands of dollars to go down until market close. ETFs or index funds on the other hand, are usually sold as market orders at the moment you press the sell or fill button. This is one reason many 401k investors prefer ETFs or index funds to mutual funds.
Call your advisor for advice. Don't email your advisor, they can't and shouldn't be sending you advice via email. Call them and ask what you should do. This is why the plan hired them in the first place, so make them earn their fees. Ask them what they feel is in your best interest. Ultimately, you have the make the decision, but 2 minds are usually better than 1, and the advisor will be watching markets all day (or at least they should be).
This list is obviously short and to the point. There are more things you probably should do during a market crash, but we feel like these are the top 5. Also, doing nothing is a fine strategy if you've thought through the points above already and your investments are where you want them to be. Being proactive will help immensely when the bears rear their angry heads and the market dips. A crash is always coming so do what you can to prepare to ride out the storm.