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If all of the recent trouble with COVID-19 and the economy slipping into an official recession are making you wonder if you should even still be contributing to your 401k, then let me offer some positive news.
Though it can seem counter-intuitive at first to be pumping money into a portfolio that seems to be sinking faster than the Titanic, one thing that most people forget is that one day the markets are going to be up again.
Economies are cyclical, meaning it's normal for them to go up and down when you look at them over the long-term. And one of the best times to invest is when the economy is in a downward cycle. In fact, if you can bump up your contributions to your 401k or other retirement savings, that can lead to potentially big money for you later on!
Let me show you what I mean by going back to our last big recession …
My Lost Opportunity During the Great Recession
It was 2009 and the stock market seemed to fall into an endless black hole. The subprime mortgage crisis had finally taken its toll on just about every part of the U.S. economy, and businesses everywhere were either slowing down or shutting their doors for good.
Earlier that year, I just received my annual company bonus and had about $10,000 to invest. Over the past few years, I had started buying up some mutual funds, and I really wanted to continue doing that this year, but how could I? With the Dow Jones having crumbled to 7,062 points from 14,066 just a year and a half ago, I’d have to be crazy to throw any money into the game now, right?
I chickened out and decided to simply park that money into an online savings account instead.
Boy, was that a mistake!
In just over two years, the stock market had rebounded and we were back up to 2007 levels. Had I put my money (and faith) in the stock market, I would have doubled my money.
By February of 2020, the market was at an all-time high – over 4 times the level it was from the 2009 low point. That means my money would have quadrupled to over $40,000!
In hindsight, my mistake was one of perspective. Rather than seeing the market crash as something to fear, I should have seen it for what it was: An opportunity to buy assets while they were on sale.
One of the golden rules to investing is to always “buy low and sell high”. And that’s exactly what I should have done then. I should have seen the market dip as an opportunity to scoop up as many funds as possible while they were selling at a discount.
Here’s how that works and how it can grow your net worth over time.
Why You Should Bump Up Your Contributions During a Market Dip
First, let’s look at what happens inside your retirement plan if you don’t make any changes to how much you contribute and simply stay the course.
First of all, remember that when you contribute to your 401(k) or IRA, you’re usually investing in mutual funds that are just combinations of different types of stock and bonds. As the markets move every day, the value of these funds will shift up and down in response.
Every contribution you make to these retirement plans is effectively a fixed amount of money. For example, let’s say that your contribution to your 401k each month is approximately $500. If during the good times you’re regularly buying funds at an average price of $10 per share, then this means you’re buying 50 shares per month.
When the markets head south, those shares are going to decrease in value. For our example, let's say that they go down by 25%, to $7.50 per share. That means if you keep up with your $500 per month contributions, you’d be buying 66.7 shares instead of the 50 that you were previously buying. The longer the markets stay low, the longer you are adding these discounted shares to your portfolio, buying a higher volume than you normally would.
Now as the market heads back up and those shares return to a value of $10 each, you’ve got a few good things going on for you. All of your pre-market crash shares have now returned to the value they used to be, and so as long as none of your assets were sold, you haven’t lost any money.
But more importantly, all the shares you bought at the discounted price of $7.50 will have effectively made a 33% gain. Not a bad return!
The only thing that would have made this situation even better is if you had bought even MORE shares while the markets were down. Hence, this is why my advice to you is to look past the initial market panic and bump up those 401k contributions as soon as possible.
Here’s how you can do that.
How You Can Take Advantage of a Discounted Market
When I think back to my missed opportunity during the Great Recession, what I should have done was find a way to boost my contributions all the way up to the IRS maximum limit. As of 2020, that’s $19,500 for a 401k and $6,000 for an IRA (or if you’re 50 and older, $26,000 and $7,000 respectively).
Recession or not, contributing as much as possible to your retirement plans is a great way to accelerate building your net worth. Not only will you take full advantage of the power of compounding returns, but you’ll also achieve financial freedom as quickly as possible.
I’ve found that the best way to accomplish this is to just start increasing your 401k contributions little by little. If you get a raise or change positions, then you could easily divert your new income into your retirement savings.
No raise this year or promotion? That’s no problem! Just increase your contribution rate by as little as 1 percent every 6 months and then adjust your spending habits as needed. Trust me, you’ll hardly even notice the dip in your income after a month or two.
Where can you find more money to put towards your 401k contributions? The first place I would look is at the bills you’re paying right now. For example, when was the last time you shopped around for cheaper car or homeowners insurance? About every two years when I do this, I get all kinds of offers that are anywhere from $50 to $100 cheaper per month than what I was previously paying.
What about your discretionary spending? Do you find yourself eating out or buying things online that you probably don’t really need? Do you have subscriptions to apps or services (such as premium movie channels) that you rarely ever use? Even if it's just a few bucks a month, these can all be easy places to make cuts and start putting the money towards building your nest egg instead.
Most importantly, don’t give into the market drama and panic that you’ll see on TV or the Internet. Though recessions can be rough, they can also be opportunities to invest that only come around once or twice in a decade. The next time you start to hear the media panic about market losses, just remember the sage philosophy of the great investing guru Warren Buffett: Be fearful when others are greedy and greedy when others are fearful.
Contributor’s opinions are their own. Always do your own due diligence before investing.
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