Stock market corrections can often look very scary. That is a problem because fear is every 401(k) investor’s worst enemy. It is what drives 401(k) investors to make irrational and shortsighted decision. instead of sticking to a coherent strategy.
What Is a Correction?
Here is a quick refresher. A market correction is a decline of 10% or more from the most recent peak.
There are two key issues driving the markets into correction territory. The first is an old story, one we have been dealing with for over a year now. The second is newer, at least to those of us living on this side of the Atlantic.
I am referring, of course, to inflation and Ukraine.
Inflation
Let us start with inflation. As you know, the ongoing pandemic has wreaked havoc on global supply chains. This has caused prices to rise on everything from cars, to food, to toiletries. At the same time, the economy has expanded. Due to the Fed keeping interest rates at historic lows. The result? Skyrocketing inflation.
For months, investors have been expecting the Fed to raise interest rates. Many analysts expect the Fed will raise interest rates several times this year. And it could happen as early as this week.
The interest rate/inflation story is unlikely to go away anytime soon. But now, the markets have a new question mark to deal with: The prospect of Russia invading Ukraine.
Ukraine
In recent weeks, Russia has moved over 100,000 troops near the Ukrainian border. This has NATO — of which the US is a leading member — concerned. (Remember, Russia annexed Crimea from Ukraine back in 2014.)
All the major nations in the region are currently engaged in diplomatic talks. But the situation is growing so serious. The U.S. has ordered all family members of embassy personnel in Kyiv to leave Ukraine.
Why has this developing story had any effect on the stock markets at all? The reason can is a single word: uncertainty.
Will Russia invade Ukraine? No one’s certain. What would happen if Russia did? No one’s certain. What will the US and other Western countries do about it? No one’s certain.
What if the US were to levy sanctions against Russia? Or prevent Russian banks from doing business with the US financial system? No one’s certain.
The stock markets hate uncertainty.
Our Strategy
Stock market corrections can worsen into bear markets. A major stock market decline can have a significant impact on your 401(k) portfolio.
We do not believe in panicking during a stock market correction. Neither do we believe in standing still. For this reason, our strategy calls for us to:
1. Analyze stock market trends instead of stock market headlines. Is a particular mutual fund, asset class, or the stock market as a whole trending down? If so, what are the underlying causes? How is it likely to impact your 401(k)?
2. Follow our rules that determine at what point in a trend we decide to buy, and at what point we decide to sell. For example, if a 401(k) mutual fund price gives us a sell signal, we follow “the rules” and sell. Period.
3. Be prepared at any time to “switch to defense” and move to cash to protect your 401(k) principal.
Uncertainty abounds in the markets right now. And nobody knows with certainty what will happen. We are no exception.
We will not “do nothing” like the average buy-and-hold 401(k) investor. We will react to the change is the stock market risk level. We then follow our pre-determined “stop loss” rules.
And that is how we deal with a 401k) stock market correction.
Ric Lager
Lager & Company, Inc.
