The last few months have been a wild ride for the stock market. The S&P 500 and the Dow Jones Industrial Average both experienced one of their worst first quarters in history, and it's been a rollercoaster of ups and downs over the last couple of months.
These are uncertain times for investors, because there's no telling just how long it will be before the economy bounces back and the stock market stabilizes. While there's not much you can do to speed up the market's recovery process, there are a few mistakes that could potentially cost you a fortune.
1. Cashing out your 401(k) if you lose your job
More than 36 million Americans have filed for unemployment benefits over the last two months, and if you're contributing to a 401(k) through your employer, you'll need to decide what to do with those savings if you lose your job.
Your best options are to either leave your money where it is, roll your investments over to an IRA, or wait until you find a new job that offers a 401(k) and transfer your money then. You do have the option of cashing out your 401(k) when you leave a job, but that could potentially be a costly decision.
Cashing out your 401(k) is considered a withdrawal, and early 401(k) withdrawals made before age 59-1/2 are typically subject to income taxes and a 10% penalty. The CARES Act has temporarily waived the 10% penalty for coronavirus-related withdrawals up to $100,000, but if you have a significant amount of money in your 401(k), taxes alone can still amount to a hefty chunk of change. In addition, cashing out your 401(k) limits your money's growth potential because you're missing out on valuable time to let your investments compound.
2. Panic-selling your investments when the market falls
When the stock market takes a nosedive, it's human nature to want to do something. You may be itching to pull your money out to salvage what's left of your portfolio. But if you sell your investments right now, that could end up doing more harm than good.
The best time to sell your investments is when the market is flourishing, because that's when stock prices are at their highest. That also means one of the worst times to sell is during a recession when the market is down, because stock prices are lower. By pulling your money out of the stock market during a market downturn, you're selling your investments for a bargain -- and locking in your losses.
Although it's not easy, one of the best things you can do when the market falls is stay the course. You won't lose any money until you sell your investments, so if you leave your cash in the stock market, you can ride out the storm and watch your savings rebound as the economy recovers.
3. Being too conservative
A market downturn can be nerve-wracking, and it may be tempting to move your money to more conservative investments in the future. By allocating more cash toward investments such as bonds, your savings are less susceptible to wild ups and downs than if you'd invested primarily in stocks. However, if you play it too safe, it's far more difficult to reach your saving goals.
Stocks may be inherently riskier than bonds, but they also see much higher average rates of return over time. For example, although stocks may see dramatic ups and downs in the short-term, the S&P 500 has experienced a historic average annual return of around 10% since the index's inception. Bonds, on the other hand, may only see returns of around 4% to 5% per year.
When you're saving for retirement, you'll want your money to grow as much as possible. If you're investing primarily in conservative investments like bonds, you'll need to contribute far more to your retirement fund each month to save as much as you need. So although stocks may be somewhat risky in the short-term, not investing in stocks may actually be riskier long-term.
The coronavirus pandemic has caused significant financial hardship for millions of U.S. households, and there's a good chance you've watched your investments take a hit over the last couple of months. Although these are uncertain times, rest assured that your savings will bounce back eventually -- as long as you invest wisely and avoid these expensive mistakes.
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