Stock market risk management is an essential element of 401(k) investing. Few individual 401(k) investors know what risk management means.
Let us be clear about what I mean using stock market risk management. With my 401(k) advice clients, I use the term “manage risk.” I mean a 401(k) investment management strategy to limit the amount of potential 401(k) principal loss.
While managing stock market risk in a 401(k) sounds good. But I strive to make my 401(k) advice clients aware of the most important risk management problems.
One problem is that no one can expect a meaningful stock market decline. Like one you would want to avoid in your 401(k) account. Part of this problem is that it is also impossible to determine how much the stock market will decline.
On the other side, no one can expect the moment the stock market stops falling. And begins to go up. Limiting 401(k) principal loss has nothing to do with upside investment returns.
I have experienced frustrations over the years with many of my 401(k) advice clients. Their 401(k) principal losses are limited most times. So why can’t I tell them when to reinvest in the right 401(k) mutual funds at the right time?
There is one more stock market risk management problem. “Managing the risk” can sometimes also lead to minimizing investment returns. That unfortunate fact is the other side of stock market risk management.
The only way to limit 401(k) principal losses is to reduce exposure to the stock market. That part works well.
Here is the hard part. Stock market risk management lowers exposure to stock market mutual funds in a 401(k). But it may also lower exposure to the stock market on the days it finds a bottom. Especially if that day is a meaningful “bounce” that gains the financial headlines.
The truth is that managing stock market risk in a 401(k) will help preserve principal. There are also times when stock market risk management will underperform the stock market. Especially over the short term.
My 401(k) advice clients have come to live with short term 401(k) underperformance. At major inflection points in the popular stock market averages.
For them, the potential 401(k) principal loss downside is scarier. And much harder emotionally and mentally to live through.
Every 401(k) investor wants all the stock market upside. All the time. And they want none of the downside. Ever.
But I tell my 401(k) advice clients the hard truth. They may not like to hear it. And they especially do not like to live through it recently.
Ric Lager
Lager & Company, Inc.
