7 Costly Reasons You Should Never Touch Your 401(k) When the Market Crashes

If you're reading this article, you likely already have a smart retirement strategy by investing in a 401(k). But market fluctuations may have you second-guessing yourself.

Like Peter Lynch, the former manager of Fidelity's Magellan Fund, once said, "The real key to making money in stocks is not to get scared out of them." 

This means standing by your convictions and remembering why you invested in stocks in the first place. After all, you are a long-term investor aiming for a comfortable retirement.

Now, here's why sticking to your plan (even during rough patches) is such an important part of honing your financial fitness.

Market volatility is normal

Expect ups and downs in the value of your 401(k) through the years. This is part of the process, and down years can help you.

Historically, every five years, the S&P 500 declines 20% one or two times. This is simply the nature of the market. If you keep contributing to your 401(k) during down periods, you can buy more stock because the prices are cheaper.

Keep your emotions in check and ignore daily fluctuations or monthly rises and drops. Remember, your 401(k) is for your retirement. So, unless you're within five years of retiring, you most likely don't want to make a knee-jerk reaction to a drop in value.

Timing the market is nearly impossible

Wouldn't it be great if we could predict the future? Billionaire investment analyst Ken Fisher advises, "Time in the market beats timing the market."

If we knew ahead of time about an upcoming pandemic or a new law impacting certain businesses, or if we could predict the success of a new technology, we would be able to invest in stocks that would benefit.

Unfortunately, unless you have insider knowledge and plenty of money you can risk losing, it's to your advantage to continue investing consistently. This way, you're taking the less risky approach of believing that the overall market will grow over the years.

You could miss the market's best days

According to Fidelity Investments, if you had invested $10,000 in 1980 and held strong through recessions and market busts until the end of 2022, you would have reached a final balance of $1.082 million.

However, if you had missed the market's five best days because your money wasn't invested, you would have been left with only $671,051. If you missed the 10 best days, your windfall should shrink to just $483,336. 

Withdraw your investment and miss the 30 best days? You'd be trying to retire with just $173,695. The lesson is that we don't know when the best days will be, so stay invested to ensure you don't miss out.

You risk selling too low

You've heard of the investment adage, "Buy low and sell high." This is easier said than done.

That's because it can feel scary when the value of your 401(k) keeps dropping. You might feel anxiety or even panic and think, "I'd better sell now before it's too late and I lose all my money."

If your 401(k) is full of diversified investments, such as an index fund, you trust that the entire market will eventually rebound before you need to cash out for retirement.

You might remember how the U.S. stock market was rocked during the COVID-19 pandemic. On March 9, 2020, the stock market lost nearly 8% in one day. But folks who panic-sold missed out because the market recovered in about four months.

So don't "lock in" your losses. Stay the course and think about years, not days, weeks, or months.

You should focus on long-term growth

Your 401(k) is designed to take advantage of long-term gains. Warren Buffett imparts this wisdom: "The stock market is a mechanism for transferring wealth from the impatient to the patient."

You're counting on your big basket of various investments, such as bonds and stocks in America's most successful businesses, to weather all storms and come out stronger than before. And over the long term, that's exactly what happens, as the stock market returns around 10% a year. 

Unless you need money from your 401(k) to pay for immediate necessities, you're almost always better off letting your investment grow.

Compounding interest works best with patience

Compound interest is when you earn interest on your initial investment, plus you earn interest on the interest you've earned. Imagine a small snowball rolling down a mountain. 

It keeps picking up more snow as it rolls until it's a giant snowball. Set your snowball of money in motion, and don't interrupt its progress.

Think briefly about how credit card companies make a fortune by charging compounding interest on outstanding debt. You can play that game, too, by reinvesting your dividends and keeping your 401(k) intact.

You'll pay a penalty

A 401(k) is intended to fund your retirement. That's why the law indicates you must wait until 59½ to access the money without penalty.

You may owe a 10% penalty plus income tax unless you qualify for a few particular circumstances.

Bottom line

The final value of your 401(k) will very likely determine your retirement readiness. Remember, that's the final value when you withdraw, not the value today, tomorrow, or even next year.

If you keep your money invested, embrace the power of compounding interest and big market rebounds, and believe in the U.S. economy's long-term strength, it will pay dividends when you retire.

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