Tales of a Technician: How Do I Protect My 401k? | Tackle Trading
Nothing like a stock plunge to reignite interest in portfolio protection. No one cares about umbrellas until it starts raining. As I write this (Jan 20th) a sea of red is flickering in my peripheral vision. Oil is down 6% and seemingly on its way to zero, emerging markets are down 4% and the U.S. is down 3.5%. This, mind you, on top of the gajillion percent they’ve already fallen. Capitulation looms but each and every time the bulls try to grasp it for a lifeline it sadistically jumps just out of reach. One day this cat and mouse game will end and true capitulation will arrive to usher in the long awaited, and hopefully epic, snap-back.
I’ve received more than a few requests to opine on how to protect retirement accounts during such painful plunges. And, as you might imagine, I have opinions aplenty to share. Let’s begin.
First, mind your time horizon. I’ll use myself as an example. I have a solo 401K with TD Ameritrade invested passively in ETFs of varying shapes and sizes. I’m 31 and the money in this particularly account is earmarked for retirement — a couple decades away. I decided the optimal asset allocation when I first setup the account, placing the appropriate percentages in stocks, bonds, and the like based on my risk tolerance and long-term time horizon.
So what do I do know that the market is in panic mode?
Nothing, really. If anything I’d be rebalancing here. Mostly buying stock ETFs to bring my allocation back up to where it should be.
What, you want me to sell here? After the Russell 2000 has already plunged 26%? Not a chance. Quite the contrary I view this as a sale, an opportunity to add-in this year’s contributions at a much better spot. Each $1 invested is buying more shares than they did just two months ago.
But, but, what if the market goes down 30% or, dare I say it, 40%?
Then, fantastic, I’ll buy even more. The question for my retirement account isn’t, “where’s the market going to be next week or next month?” It’s, “where is it going to be a decade or two from now?” That’s the time frame that matters for the money in this account. And I assure you the market will be higher (my opinion, backed by historical evidence galore, of course).
So how do I protect my 401K in this situation? By not selling. By keeping my grubby, panic-prone digits away from the sell button. That’s how.
Now, I know many of you don’t like that answer (even though it’s a good one for me). So, what else might we consider?
The principle issue facing those with a classic 401K is the lack of choices. Really, there isn’t much you can do aside from the following (not a recommendation, just stating the facts, Jack):
One: Move your money from their current home of a variety of mutual funds to cash or cash equivalents.
Two: Shift the allocation so it’s positioned more conservatively — more in bonds, less in stocks.
That’s about it. But what about buying protective puts?
You could do that, but it would probably have to be in a separate account you setup. Unless, like me, you have a solo 401K which allows you to trade options. My bet is 99% of you with 401Ks don’t though, since your 401K is with an employer.
Buying protective puts is a whole other discussion warranting its own post (I have one coming down the pike). But, sure, you could buy some portfolio insurance. Matter of fact, I have a lovely couple I mentored last year that did just that and were able to partially offset the loss in their passive accounts during the recent downturn.
Here’s the problem you MUST avoid. Making an ad hoc decision to do one of the prior three suggestions in the heart of a crisis. You MUST setup whatever your plan is BEFORE the market downturn so it’s well thought out, tested, and you have the confidence it will work. Selling out of stocks now, or moving everything into bonds, or snatching up the currently pricey put options does not seem prudent.
Final thought. Was your 401K account value near an all-time high in 2015? I bet it was. Particularly if the bulk is invested in U.S. stocks.
Why?
Because 1) you didn’t panic out during every other correction that you’ve experienced along the way and 2) you kept contributing despite the ups and downs.
Question: if that’s what drove your account to an all-time high in the past, why would panicking and selling everything now all of a sudden be the best course of action?
Financial freedom is a journey
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Originally published at tackletrading.com on January 25, 2016.
