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Key points

• A recession is a time of significant economic slowdown.
• The value of the investments in your 401(k) will likely decline during a recession.
• Most equities will eventually recover from a recession-induced pullback.

A workplace 401(k) is many people’s first exposure to investing. It can be exciting to see your balance grow as you — and possibly your employer — start contributing. But stock market pull-backs like the recent global sell-off are stark reminders that account balances also go down. It’s natural to worry that a recession will inhibit your ability to retire and on time.

Generally, the best course of action during a recession is to hold onto your investments and avoid making fear-based decisions. Staying invested allows you to buy shares at bargain prices during a market downturn. 

Recessions and the stock market

91Ӱ�� stock markets have recovered in time from a downturn. So, the value of your investments should eventually bounce back. But the period during which your 401(k) declines may be alarming. 

It can be helpful to understand why recessions happen in the first place. A few reasons include:

• An overheating of the economy when it’s expanding at an unsustainable rate.
• Asset bubbles are similar to what we saw leading up to the Great Recession.
• Economic shocks or unexpected economic events, such as the COVID-19 pandemic.

Overall, recessions can have several negative impacts on the economy. Because of the reduced economic output, some businesses may be forced to close their doors. Others lay off employees, which leads to increased unemployment. Finally, asset prices, including those in your 401(k), often decline. 

Are we headed for a recession?

Rising unemployment can also signal an impending recession. In August 2024, a poor jobs report coupled with a global stock market sell-off resurfaced 91Ӱ�� recession fears. 

Even if there are signs of a recession, there are definitive markers for calling a recession. The National Bureau of Economic Research defines a recession as a significant and extended decline in economic activity. Typically, this amounts to two consecutive quarters of gross domestic product decline. So far, the 91Ӱ�� GDP for this year is positive.

What is a 401(k)?

A 401(k) is a type of employer-sponsored retirement plan offered by many private sector companies. Employees can defer money from their paychecks into their 401(k) accounts. This money is taken from your paycheck pretax, meaning it reduces your taxable income for the year. You only need to pay taxes on it once you withdraw it from your 401(k).

Starting in 2024, the IRS allows individuals to contribute up to $23,000 per year to their 401(k) plans. Workers 50 and older can contribute an additional $7,500 per year. Many employers also contribute to their workers’ 401(k) accounts by matching a portion of an employee’s contribution.

You can invest money in your 401(k) based on a menu provided by your employer. Most employers offer their employees the choice of mutual funds and target-date funds. The default investment is usually a target-date fund. These funds are designed to be single-fund solutions for retirement investors, which become more conservative as they near the target date for retirement.

Recent 401(k) performance

Overall, 401(k)s have performed well throughout the past decade. On average, balances across all 401(k)s on Fidelity Investment’s platforms increased by over 39% since 2014.

Balances have nearly doubled since 2007. This is despite having endured two recessions: the Great Recession from 2008 to 2009 and the COVID-19 pandemic in early 2020.

Average 401(k) balance and rate of return, 2007-2024

Average 401(k) balances and rates of return will decline during a recession. But there are years of great returns after a recession. The year after the 2020 COVID-19 recession was a strong year for returns.

Meanwhile, one of the worst years for 401(k) returns didn’t even correspond with a recession. It was 2022, when 401(k) balances dropped nearly 20% on average. In general, investors who hold out during these downturns typically come out ahead long term. 

401(k) performance: 2024

This year has been good for 401(k)s overall. According to Fidelity, the average annual return is over 13% as of the second quarter. 

But this doesn’t account for the August sell-off. That said, the market is already on course for a rebound. History also shows that the market often posts its strongest returns immediately after a decline.

Comparing past 401(k) performances

Past performance does not indicate future results, as they say in investing. But comparing past 401(k) performance can alleviate some of the anxiety around recessions and declines. You can see that bad years are par for the course. But on average, 401(k)s trend up over the long term.

The key is to remember that you haven’t lost anything until you sell. The best strategy is often to just grin and bear it. 

What can happen to your 401(k) in a recession?

A recession, unfortunately can hurt asset prices and your 401(k) balance. 

The S&P 500 has lost an average of 8.8% of its value during the four recessions since 1990, according to CFRA Research.

The tables below show the length of prior recessions and stock market performance during each of those recessions, as well as before and after, according to an October 2022 report published by HBKS Wealth Advisors.

Of course, not all recessions behave the same. In 2008, during the Great Recession, the stock market fell by more than 38%. The effect on your 401(k) would have been more noticeable. That said, the one feature all recessions have in common is that they’re temporary. So your 401(k) can recover if given enough time.

How to protect your 401(k) in a recession

It’s natural to wonder what you should do to protect your retirement savings. You might be surprised to learn the answer: nothing. At least, nothing different from what you’ve been doing.

“That’ll take some grit because it’s certainly not easy to see a drop in your life savings,” said Eric Phillips, a chartered financial analyst. “Money can be emotional, and it’s hard to manage the fear, anxiety, and other emotions that have you worried about your financial picture today and tomorrow.”

The latest market downturn may have caused a dip in your 401(k). But this means it’s the worst time to sell. If you sell or stop contributing now, you’ll be doing so when prices have dropped. Then, you won’t see the benefit of your stocks rising in value as the market bounces back.

“Ideally, you’re invested with a long-term strategy in mind and, when the market returns, you’ll see the gains and growth,” Phillips added. 

5 steps to protect your 401(k) investments

The following steps could help you make the best of a recession. They’ll help you protect your investments while still planning for future growth.

1. Continue contributing to your 401(k) plan 

First and foremost, don’t abandon your retirement planning during a recession. Many people invest using a strategy called dollar cost average. This is when you invest a specific amount regularly. For example, you might have $100 from each paycheck contributed to your 401(k) plan. 

There’s no reason to pause these contributions during a recession. 

2. Maintain a well-diversified portfolio

Diversification is one of the most important principles for long-term investing. It involves having many different assets in your portfolio. This ensures you aren’t putting all your eggs in one basket. An easy way to diversify your 401(k) portfolio is to invest in a target-date fund.

3. Consider investing in defensive stocks

Defensive stocks are those that typically perform well during recessions and other economic downturns. These companies fall within sectors people must spend money on, regardless of the economy. 

4. Opt for value over growth stocks 

Generally speaking, value stocks outperform growth stocks. Value stocks are priced relatively low relative to their earnings, while growth stocks are companies growing faster than the market overall. 

Part of the reason for this is value stocks are often more affordable. This is an attractive quality during a market downturn. Another reason is growth stocks tend to require more capital for growth. That capital might be more difficult to secure during a recession.

5. Make room for income-producing assets

Income-producing assets like bonds and dividend stocks can be a good option during a recession. 

Bonds tend to perform well during a recession and pay a fixed income. Similarly, dividend stocks pay regular income regardless of how the stock market is performing. The caveat is that a dividend-paying company may suspend or reduce its dividend.

Frequently asked questions (FAQs)

Should you reduce 401(k) contributions during a recession?

Aim to contribute as much as possible to your 401(k) regardless of economic events. A recession is one of the best times to contribute to your 401(k). Buying investments while the market is down is like shopping on sale. 

Does a 401(k) recover after a recession?

Your 401(k) can recover after a recession if given enough time to regain losses. Historically, the stock market has always recovered from recessions to eventually reach new highs.

Should I cash out my 401(k) if the market crashes?

The worst thing you can do to your 401(k) is to sell if the market crashes. Market downturns are generally short and minimal compared to the rebounds that follow. As long as you hold on to your investments during a downturn, you haven’t lost anything.