Art of the Smart

4 Ways To Hedge Your 401(k)

Categories: [finance]
Tags: [retirement]

401(k) retirement accounts have limited flexibility in what you can and can't do, and that can limit how you protect yourself against downturns in the economy. Let's look at a few easy ways you can hedge your bets so you can exercise your risk preferences and sleep well at night.

There's been some talk lately that there might be a market correction coming. The old joke goes "Economists have predicted 10 out of the last 4 recessions" but we should still consider what to do when you think things might not be all sunshine and rainbows in the future. In particular, 401(k) accounts have some serious limitations in what you can do with them, most notably you generally cannot trade derivatives and often you can't trade stocks at all. But that doesn't mean you can't take your foot off the gas a little so you don't go over the cliff full throttle.

That said, you should always try to maximize your annual contribution. Unless you need the money or you're certain there's a correction in progress, it's usually better to maximize the contribution each year than to miss out. Yes, even if there's a correction right afterwards.

Below are 4 methods you can use, with the later ones being more extreme.

Reallocate 401(k) Funds

This one is easy and something you should be doing periodically anyway! Just rebalance your 401(k) into asset classes that are less risky. If you’re holding a lot of value shares, small caps, or sector tracking funds (like financials or technology), try diversifying into something more basic like a target retirement fund or a bond fund. You don’t need to move it all over, just enough to ease off the risks inherent to stocks or industries.

Another option is to shift into securities that don’t move so violently during a market correction (like basic consumer goods, discount retailers, fast food, and utilities).

You can always undo this later and you’ll still capture some market gains if things continue to go up.

Delay Contributions

Another easy thing to do is to delay your contributions or lower them in the near term if you think something bad is around the corner. No need to rebalance or change your approach, just hold off on contributing to the account for a bit and double-down in the second half of the year (or fourth quarter). This has the effect of taking a little skin out of the game without moving assets around.

Plus you get a little extra cash in the meantime. You know. Get yourself a little something nice.

Hold Cash/Bonds

You can just sell stuff. No need to allocate all the money in your portfolio to something, you can sell a few of your fringe holdings and just hold cash for a bit. The idea being that if the market goes into a correction, you can use that money to buy assets at a lower price.

Reallocate Other Funds

Investing is like cooking, and a 401(k) account is just one ingredient. But it’s a composite ingredient; it’s like ketchup. It has salt, and sugar, and vinegar, and other stuff that isn’t quite like cooking with any of those ingredients individually. If you were cooking with such an ingredient, you’d back off the salt a bit, or you’d use that vinegar to season the dish rather than be a main ingredient.

In the same way, your retirement account can be hedged by changing other stuff outside of it to get the same effect. Some examples: