Your 401K Is Now A 301K
As I write this note in mid-October of 2022, the US stock market is down 25% year-to-date and the bond market* is down 15%. To add to the pain, we’ve taken another 8% hit in our purchasing power from inflation.
It’s a rout.
This drop in bond values is historic. 2022 will likely go down as the worst bond market performance since records have been kept for the past 100 years. Bonds are supposed to be the ballast in your portfolio during stormy seas. Not this time.
I’ll offer a few perspectives that may ease your anxiety.
1. You’re not alone.
For many of us, our sense of self-worth is tied to comparing ourselves to others. If you’re feeling ~20% poorer from the declines in the investment markets, you’re not alone. You can be sure that friends, neighbors, and family all experienced similar drops in their net worth. Misery loves company and you’ll find plenty of it.
2.Time heals all wounds.
Or, as Groucho Marx said, time wounds all heels.
Maybe this time will be different but the stock market has always bounced back in the past — sometimes quickly and sometimes slowly. It took ~6 years for the stock market to completely bounce back from its 2007 pre-financial crisis high, but only a few months from the COVID panic of early 2020.
I don’t know if we’ve hit bottom or how long the bounce back may take, but if it doesn’t rebound eventually, this would be the first time.
3. Anchor on a longer time period.
Yes, it’s been a terrible year for your investments, but try not to anchor on this very recent past. Over the past 10 years, the stock market has averaged annualized returns of nearly 11% — more than doubling during this time. If you’re old, this has been a very good 10 years; if you’re young, well, see my next point.
4. If you’re young…
At the risk of sounding glib, in many ways, a stock market rout is a net positive for the young. Huh?
Most of your lifetime savings are still to come and now investing is having a 25% off sale. You can buy 25% more “units” of investing than you could last year and you have a lot left to accumulate. That’s great news as I’m sure you wouldn’t mind if Amazon announced a 25% off sale on everything until further notice.
Yes, you’ve lost a large percentage of your existing savings but over your lifetime, this is negligible compared to the total net worth that you’ll hopefully amass. You’re paying a small price (a loss in your current savings) in return for a big bargain in making future investments at 25% off. That’s a great trade.
Another way to frame this is to think of your “net worth” as having several components:
- Your current savings (net of any liabilities)
- Your future Social Security benefit stream
- Your future income stream
If you’re young, #3 dominates. Hopefully, you’re going to have a lifetime of a growing income and over these years, you’ll be adding substantially to your savings. When you think of your net worth, include your future income stream.
So for younger adults, your overall “net worth” has barely shrunk because most of it is based on the present value of your future income and that hasn’t changed. Keep saving as aggressively as you can and take advantage of the 25% off sale while it lasts.
5. If you’re near or in retirement…
For those of you of a certain age — i.e., nearing or in retirement — the stock and bond market rout is not welcome news. Retiring during a stock or bond market decline is just one of many uncontrollable risks you face in your retirement years.
This situation is tougher in your circumstances. You may have carefully planned out your retirement cash flows based on a savings balance you no longer have and may need to now cut back on your future spending. However, it’s not as bad as it first sounds.
- For most retirees, Social Security is a critical component. Due to the annual COLA (cost of living adjustment), your benefit will be nearly 9% larger next year. If your income consists of your Social Security plus IRA distributions, then your total cash flow will not decline by nearly as much as the drop in your savings.
- Similarly, if you have a pension or a lifetime annuity, those payments, while perhaps not getting a COLA, are locked in regardless of the stock market.
- If you own a home, its value has likely been climbing over time. Yes, it’s true that if you want to continue to live there, you cannot cash in its value. But over time, you can choose to downsize and cash out some portion of your home equity.
- If you have not yet retired, you may opt to work a bit longer. Even a small delay in retirement can have significantly positive effects on your finances as it means you have: (a) fewer years to draw down savings to support yourself, (b) more earnings to contribute to your savings, and (c) a larger Social Security benefit due to additional years on your earnings record.
6. Harvest your taxable losses.
Finally, for your taxable savings, realize any losses you have now incurred. Even if you cannot benefit from capital losses this year, you can apply $3,000 of losses to your regular taxable income and carry forward the balance to use in the future. You’ll be glad you did so if you have future capital gains.
No one is happy after a major stock market decline, particularly when coupled with a historic drop in bond values. However, in most circumstances, it’s not as bad as it feels in the moment. And, if you’re young, take advantage of the 25% off sale on all investing.
* There are lots of measures of the “bond market.” I’m using Vanguard and Fidelity’s flagship intermediate term bond index funds as my proxy for the overall bond market.