How to Protect Your 401(k) From a Stock Market Crash

Despite what was seen in the 2010s, the stock market cannot go up forever. Corrections typically occur every few years when stocks decline 10% or more from their most recent peak, sometimes lasting several months at a time. Stock market crashes, on the other hand, are less common than corrections but are more abrupt and severe. For proof, one has to look no further than the 2008 financial crisis or the 2020 crash during the COVID-19 pandemic. Thankfully, preparing for market volatility ahead of time is possible.

A financial advisor can help you make moves to protect your retirement savings from market volatility.

Protecting Your 401(k) From a Stock Market Crash

Any time you put your money into the stock market or other investments, you always run the risk of losses. Even with educated decisions, things don’t always go as planned. And, when you’re talking about something as important as your retirement, emotional decision-making can also come into play.

Despite this, there are many strategies, both simple and complex, you can use to mitigate risk. Diversifying your assets across different investments can help reduce risk, helping you avoid the volatility of stock-picking and concentrated positions.

Everyone has short-term expenses that periodically arise, such as car or home appliance repairs or medical bills. Long-term expenses are even more prevalent, including student loans and mortgages.

It may seem overwhelming to add retirement savings to the mix, but it is important to make your savings a priority just like your other expenses. This will ensure your pool of retirement funds will continue to grow over time.

To begin building your retirement savings, these are some of the most influential strategies that can help minimize losses in your portfolio, even in the event of a stock market crash. Just remember that you can never completely eliminate risk, no matter what strategy you use.

Don’t Panic and Withdraw Your Money Too Early

Surrendering to the fear and panic a market crash elicits can cost you.

If you make an early withdrawal from your 401(k), you may face hefty IRS tax penalties, which won’t do you any favors in the long run. It’s especially important for younger workers to ride out the market lows and reap the rewards of the future recovery.

Even people nearing retirement age may rebound from the crash in time for their first withdrawal. Consider the pandemic-fueled crash of 2020 as a case study. The Dow Jones Industrial Average, which notched an all-time high of 29,551.42 on Feb. 12, 2020, fell to just above 19,000 by March 15, 2020. Then on April 15, 2021, it posted an intraday high of more than 34,000.

Spooked investors who pulled their money from the market in March 2020 missed out on the bull market that pushed the DJIA to record highs by November 2020 – just eight months later. The Dow reached its all-time high of 36,585 on Jan. 3, 2022, and continued to climb in the following years, crossing the 40,000 mark in May 2024.

Diversify Your Portfolio

A man worried about protecting his 401(k) during a stock market crash.

Finding the right asset allocation can be key for protecting your 401(k) from a stock market crash, while also maximizing returns.

As an investor, you understand stocks are inherently risky and, as a result, offer higher rewards than other assets. Bonds, on the other hand, are safer investments but usually produce lower returns.

A mix of the two could help diversify your portfolio while reducing risk.

Building a Diversified 401(k)

Having a diversified 401(k) of mutual funds and exchange-traded funds (ETFs) that invest in stocks, bonds and even cash can help protect your retirement savings in the event of an economic downturn.

Your overall asset allocation depends in part on how close you are to retirement. The further you are from retiring, the more time you have to recover from market downturns and full-fledged crashes.

Therefore, workers in their 20s would likely want a portfolio more heavily weighted in stocks. Their coworkers who are nearing retirement age, on the other hand, would probably have a more even distribution between lower-risk stocks and bonds to limit exposure to a market drop.

Using the Age-Based Rule of 110

There is still the question of how much of your portfolio should be invested in stocks vs. bonds.

A general rule of thumb is to use the Rule of 110, which subtracts your age from 110. This tells you the percentage of your retirement portfolio that should be invested in stocks. You can also adjust the rule to fit your needs. More risk-tolerant investors can subtract their age from 120, while those who are more risk-averse can do the same from 100.

However, the above rule of thumb is fairly basic and limiting, as it doesn’t account for any of the specifics of your personal situation. A more comprehensive approach would be to build an asset allocation based on your goals, risk tolerance and time horizon.

It is also wise to consult a financial advisor because while you can technically create your own portfolio allocation plan,these professionals typically specialize in it.

Rebalance Your Portfolio

Rebalancing your portfolio, or changing how much you have in different assets, is another vital component of protecting retirement savings from crashes.

The idea is that over time, some investments may fare better than others, shifting the allocation of your money and potentially exposing you to more risk. By rebalancing, you bring the percentage of money invested in stocks and bonds back in line with your original investing target.

The easiest strategy to keep your 401(k) rebalanced is to invest in a target-date fund. This is a collection of investments designed to mature at a target date. They are ideal because they automatically rebalance their investments, moving to safer assets as the target date approaches. However, if you pick your own 401(k) investments, you’ll want to rebalance your portfolio at least once a year. Some financial advisors may even recommend rebalancing as often as once a quarter. You can do this by selling off positions with gains that have tipped your portfolio out of balance. This is especially important for investors who are nearing retirement.

It’s also worth noting that rebalancing isn’t the same as withdrawing money. These transactions take place within your 401(k) and won’t immediately result in taxes.

Continue Contributing to Your 401(k) and Other Retirement Accounts

Steadily contributing to your 401(k) is another way to protect from future market volatility.

Even if there is a market downturn, reducing your contributions could cost you the opportunity to invest in assets at discount prices. During periods of strong growth, it’s also important to keep contributing, even when your investments are doing well.

It’s normal to feel tempted to scale back your contributions at times during your investment journey. However, staying the course and sticking to your retirement strategy can bolster your retirement savings and help you weather future volatility.

How to Respond to a Recession

Despite the perception that recessions and stock market slumps are always related, they are distinct and call for separate responses from investors.

These guidelines can help when responding to a recession.

Seek Out Core Sector Stocks

During a recession, you might be inclined to give up on stocks, but experts say it’s best not to abandon equities completely.

Consider investing in market sectors like healthcare, utilities and consumer goods. People will still spend money on medical care, household items, electricity and food, regardless of the state of the economy.

As a result, these stocks tend to do well during busts – and underperform during booms.

Focus on Reliable Dividend Stocks

Investing in dividend stocks can be a great way to generate passive income. When comparing your options, experts say it’s a good idea to look for companies with low debt-to-equity ratios and strong balance sheets.

If you are not sure where to start, consider dividend aristocrats. These companies have increased their dividend payouts for at least 25 consecutive years, providing greater stability for their investors.

Consider Real Estate

The 2008 housing market collapse may have been a nightmare for homeowners, but, it turned out to be a boon for some real estate investors.

When a recession hits and home values drop, it can be a lucrative buying opportunity for investment properties. When you rent out a property to a reliable tenant, you can benefit from a steady stream of income even during a recession.

Once real estate values begin to rise again, you can sell at a profit.

Precious Metal Investments

Precious metals, such as gold and silver, tend to perform well during market slowdowns. However, since the demand for these types of commodities often increases during or in anticipation of recessions, their prices usually go up, too.

For example, when the Federal Reserve raised interest rates in March 2023 following the collapse of Silicon Valley Bank and Signature Bank, the price of gold and silver popped at $1,911 and $24.18, respectively.

The Importance of Cash

Some financial professionals recommend that retirees have enough cash or cash equivalents to cover three to five years’ worth of living expenses. Having cash reserves can help pay for unexpected expenditures that a fixed income may not otherwise be able to cover.

Cash on hand can also mitigate what’s called sequence of returns risk. This is the potential danger of withdrawing money early in retirement during market downturns, which can affect how long your retirement funds last. By selling low, you risk undermining your portfolio’s longevity.

However, with cash reserves, retirees can withdraw less money from their 401(k) during a market decline and instead use their cash to cover living expenses. Some financial advisors recommend having enough cash on hand to pay for up to a year of living expenses, while others may recommend having twice as much.

Assess your monthly budget and overall income to see what is best for you.

Bucket Strategy for Retirement Income

The bucket strategy is a retirement income strategy that divides your savings into three categories, or buckets, based on time horizon and risk.

The first bucket holds cash or short-term assets to cover immediate living expenses, typically for one to three years.
The second bucket contains moderate-risk investments, such as bonds, and is meant to replenish the first bucket over the medium term.
The third bucket holds long-term, higher-growth assets, such as stocks.

This setup allows retirees to avoid selling long-term investments during market downturns. Instead, they can draw from the cash bucket in the short term while giving riskier assets time to recover. As the market rebounds, they can refill the cash and bond buckets using gains from the third bucket.

This strategy helps balance growth and income needs while also reducing the emotional pressure to sell during downturns.

How to Stress-Test Your 401(k) for Market Crashes

Stress-testing your 401(k) helps you see how your retirement savings performs under different market scenarios.

This process models how your portfolio would react to events like a 10% correction, a prolonged bear market or a sudden crash. It can also help you judge whether your current asset allocation aligns with your time horizon and risk tolerance.

A basic approach is to review the performance of your stocks, bonds and cash during past downturns. Many 401(k) providers offer tools that estimate the potential impact of different types of market declines based on historical data. This can give you a sense of how your account balance could fluctuate across different scenarios. It may also reveal whether your portfolio is too concentrated in one sector or asset class.

You can also run possible scenarios using estimated rates of return. For example, you might test what happens if stocks drop sharply, bonds remain flat or inflation rises faster than expected. Each scenario will show whether your allocation provides enough stability to cover upcoming retirement withdrawals or whether adjustments are needed.

Stress-testing does not predict the future, but it helps you prepare for uncertainty. By identifying vulnerabilities early, you can refine not only your contributions but also your rebalancing schedule and cash reserve plans.

This may help you avoid making rushed decisions during a downturn so you can keep your retirement strategy on track.

Bottom Line

Safeguarding your retirement savings from a market crash takes careful attention. Keep a close eye on your asset allocation and investment variety, rebalancing when needed. It is important to continue your 401(k) contributions through both bull and bear markets. This will allow you to bolster your retirement savings for the future while remaining calm during times of volatility so you can remain positioned to capitalize on recovery.

Tips for Protecting Your 401(k)

Luckily, you don’t have to do all of this alone. A financial advisor can help you protect your retirement savings from future uncertainty. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When setting up your 401(k), take advantage of any employer match — failing to do so is leaving free money on the table!