Do 401(k)s Have Stop-Losses?

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stop lossIt never fails. My best article ideas come from my clients! Thank you!

Recently one of my clients called and asked a rather interesting question. “Do 401(k)s have stop-losses?”

First, let me define what a stop-loss is for those of you that may not know.

A stop-loss is an order that is placed, usually on a stock, to sell when the price declines to a certain level. Stock investors use them when they want a predetermined exit point when a stock declines. It can save them a boat load of cash if the security experiences, shall we say, an express elevator to the basement?

I thought the idea of a 401(k) stop-loss was interesting…until I thought about it.

First, this client was relatively young. Most 401(k) participants have some time before retirement. Ten or twenty years or more in some cases. So selling every time the market gets a wee bit nauseating can be counterproductive. I counseled him to use this as an opportunity to be more aggressive with contributions. Why not? His investments just went on sale! Face it, if Wal-Mart marked everything down between 10-30% you’d go buy something. We run like hell from a sale in the stock and bond markets.

Wouldn’t having a stop-loss on your 401(k) be sort of like market timing? You betcha. You have to know the right time to sell. Then, you have to be confident of the right time to pull the trigger and get back in. Difficult decisions at best, even for professionals. There have been studies that show if you miss even the best 10 trading days (these are days with the highest gains), your portfolio return suffers greatly. You could give up potential return hesitating to get back at the right moment.

As I spoke further to this client, he also asked me if I thought that emerging markets were causing the current market volatility. My answer was simple. Maybe. Even if emerging markets were contributing to a small sell-off so what. If you think back, only serious threats to the earnings of companies really really forced long-term slides in those stocks. Stocks, and the market, move a little on investor sentiment, headlines and such, but move up or down in the long-term based on earnings. Moral here…staying put in quality investments can often be a better option.

At last I think he finally agreed. Selling out to save a few percentage points was not advisable. I do get his point though. He’s trying to preserve capital before the next big market decline. Remember, everybody has a high tolerance for risk in a bull market. Judge your risk tolerance in turbulent times not good times. It will give you a true sense of where you need to be. If you think that this stock market is starting to make you nervous, it may be time to reassess your tolerance for risk.

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