Can a 401(k) Lose Money?

Watching your 401(k) balance grow and earn more money is a great feeling. Putting money into your 401(k), coupled with your employer’s matching contributions, then seeing it multiply makes your feel good you’re on the path to a good retirement. But can your 401(k) lose money?

Yes. Your 401(k) can absolutely lose money. Your 401(k) funds are invested in various funds like mutual funds, index funds, and target-date funds. Because these funds are invested in the stock market, either entirely or partially, they can gain value and lose value based on the performance of the stocks they’re exposed to. However, historically the stock market has returned investors about 10%.

While it’s not fun losing your hard-earned money, it’s really the name of the game. However, there are things you can do to hedge your investments to prevent you from losing as much, but you’ll sacrifice drastic gains. Also, there are things you can if you’re losing money to stop the bleeding until the market picks back up.

How do 401(k)s grow?

401(k)s are more than just glorified savings accounts that earn a fraction of a percent of interest. Consistent contributions and a smart investment strategy will give your 401(k) the best chances to grow into a sustainable retirement nest egg.

The most obvious factor when it comes to growing a 401(k) is the contributions you make to it. Automatically deducted from your paychecks, contributions towards your 401(k) are effortless. You set the desired percentage of your salary you wish to send to your 401(k), and you don’t have to think about it—although you should make a plan to check your 401(k) regularly. The best part is these contributions are tax-deferred, meaning they lower your tax burden through your working years.

Next, your employer may offer to match a certain percentage of your contributions. The average matching contribution is about 3.5% of the employee’s annual salary. All you have to do is contribute what your employer is willing to contribute to maximize this benefit.

The last way your 401(k) grows is through your investing options. The money in your 401(k) account must be invested into an investment fund in order to earn money. Most 401(k) plans provide an array of mutual funds, index funds, and target-date funds. These funds can be invested in stocks, bonds, or a combination of both. If the stock market does well, your 401(k) will grow.

The growth your 401(k) experiences can be exasperated by what’s called compounding interest. Compounding interest is the act of reinvesting the interest your 401(k) has earned back into your investments. Then that growth earns additional interest the following month—or year. Each month—or year, your 401(k)’s interest gets reinvested and continues to compound on top of each other.

How do 401(k)s lose money?

If your 401(k) can grow when the stock market does well, it’s only natural it can lose money when there is a dip in the market.

If your 401(k) funds are invested in an index fund that tracks the stock market, like an S&P 500 index fund, then your 401(k) performance is tied to the performance of that particular portion of the stock market.

Another way your 401(k) can lose money is if you reach your hands into it and take money out. While not usually advised by financial advisors, sometimes there are viable reasons to withdraw money from your 401(k) before retirement. However, if your reasons aren’t qualified by the IRS, you could be faced with a 10% penalty tax on top of the income tax you will need to pay on the amount withdrawn. So not only will your 401(k) lose the money you took out, but you’ll lose out on the tax and penalty amounts.

What to do if your 401(k) is losing money?

Your 401(k) is a long-term investment strategy. Saving for retirement hopefully starts when you’re younger and decades away from retirement.

If you’re young and you see your 401(k) losing money, the most important thing to do is to not panic. Whatever you do, don’t take money out of your 401(k). While it may be tempting to take your money out and stuff it in a safe, that’s a bad idea. You’ll be assessed the penalties from the IRS, but it’ll be more expensive to buy back into the market when it rebounds.

Losing money in your 401(k) when you’re young isn’t a bad thing. In fact, it’s inevitable. But since you’re so far from retirement, your 401(k) will likely rebound by the time you actually need to take distributions from it. Historically, index funds like the S&P 500 have returned investors about 10%.

If you’re a bit closer to retirement, you may want to consider reallocating your 401(k) investments to a bond heavier fund. Bonds are a good low reward, low-risk investment that will help you retain your 401(k)s value as your near retirement. Target-date funds typically automatically reallocate to match your risk tolerance, but it’s smart to recheck anyway.

Rollover your old 401(k)s.

If you have old 401(k)s with former employers, it’s important to roll them over to your current retirement accounts. This allows you to consolidate all of your 401(k)s into one easy-to-manage account.

If you’re unable to find your old 401(k)s, consider working with someone who has experience in this sort of thing. It’s worth it to be able to check your overall retirement portfolio’s performance and be able to make changes as necessary.