Is Your 401k Overexposed to Stocks?

Originally published by Mark P. Cussen, CFP®, CMFC, AFC | October 19, 2015

The vast majority of financial planners will tell their clients that they need to have some exposure to stocks in their 401(k) plans even if they are very conservative investors. But many 401(k) holders have ridden the recent bull market over its crest, and are now rediscovering that stocks can move in two directions. This pullback effectively serves to illustrate the impact that a domestic bear market can have on the retirement plans of older workers – and what you can do to ensure that you do not get caught unprepared.

Asset Allocation

Although many financial planners recommended the 60/40 mix of stocks and bonds through the nineties while the markets were reaching new highs, the subprime mortgage meltdown of 2008 burst that bubble for a large percentage of retirement savers. That crash and the more recent pullback in stocks have clearly illustrated the need for investors to be aware of their drawdown risk, which measures the amount of time that it will take to make up for a loss. The Dow Jones and S&P 500 Indices took about six years to regain the losses that they posted in 2008. On a practical level, this means that workers who are within five years of retirement (or at least plan on taking distributions from their retirement accounts within five years) should think twice about having their retirement plans heavily invested in stocks.

One of the disadvantages of having stock in any type of tax-deferred account is that you are not allowed to harvest tax losses as you can in taxable retail accounts. And those who purchase shares of their employer’s stock in their 401(k) plans need to be doubly careful because that portion of their plan is subject to more than general market risk. For example, what would happen if an enormous problem or flaw were found in your employer’s main product? Would you be able to absorb a 50% loss in a tenth of your holdings? If the problem is not resolved quickly, it could take years for the company to recover. (See also How Near-Retirees Can Ride Out Market Volatility.)

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