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I love going to my friend John for market advice.

Not because his advice is any good. In fact, it’s the exact opposite of good. It’s consistently bad.

That’s because John is the living embodiment of “the dumb money.”

(For anyone who doesn’t read a lot of stock commentary, “the dumb money” often refers to the general “crowd” of “folks” who are “left holding the bag” after the “smart money” gets out at the top of a market peak. The dumb money is the last man to the party… usually right before the punchbowl gets taken away. In summary, the dumb money sells low and buys high.)

Here’s what has always fascinated me about “the dumb money.” They’re not actually dumb. They just have really bad timing.

For example, do you remember Snap’s (SNAP) ultra-hot IPO at the beginning of 2017? Everyone was buzzing about it, even my friends who didn’t follow the market. After shares jumped from $17 to $24.48 — a 44% gain on their first day of trading — John decided he did not want to miss the boat. So he bought in the next day when shares were about $27, as did everyone else who was swept up in the SNAP hype.

The risk with buying into a frenzy like the one SNAP was experiencing is that there won’t be any more buyers to push the price higher. When interested buyers no longer outnumber interested sellers, prices start to drop. And that’s what happened to SNAP. Over the next few months, shares steadily declined to about $12. I think John sold when his loss was about 50%.

Like I said, John’s not dumb — plenty of other people clearly had the same idea he did. He’s just the last person to the proverbial party. When John shows up, it usually means the party is about to end.

After his doomed SNAP trade, I realized John was my very own living, breathing contrarian indicator. Whenever he started talking about buying some big trend or selling after a drop, I knew it was time to do the opposite. The key was making sure he never caught on; if he started to second guess his investing notions, it could taint the system.

Everything was great until the end of 2018, when John called me to say he was planning on moving his 401(k) into cash.

“Yeah, my account is down nearly 10% in just two months!” he explained. “I don’t think I can stand losing another 10%.”

“Mhmmmm,” I replied, half listening as I entered a buy order for some SPY. “But not all of it, right? You should never move all of it.”

“That’s what I’m saying, Mer — I’m moving it all. I’m not losing another dollar. I read the headlines. Stocks are going to keep falling, and I’m not going to lose what I’ve worked so hard to save.”

“John,” I sighed. “You can’t do that. Moving to cash now is actually the worst thing you could do for your retirement. Just hear me out…"

What You Should Actually Do When Your 401(k) Is Losing Money

When it comes to retirement planning, a 401(k) is one of the most popular and powerful tools at your disposal. However, seeing your 401(k) balance decline can be nerve-wracking, especially if you're not sure why it's happening or what to do about it.

Honestly, I totally understood where John was coming from when he said he wanted to prevent any further losses. The market decline at the end of 2018 was ugly, especially when you remember that it was the first time we’d seen a major market correction in nearly 10 years. My 401(k) was also down.

Image Source: StockCharts.com

Seeing years of savings wiped out in two months is enough to make anyone’s stomach turn. But before you hit the panic button, take a breath and remind yourself that growing your nest egg is a decades-long project.

In fact, investing your 401(k) in the stock market works so well because of that ultra-long timeline; throughout history, the market has shown us it will consistently climb over the long term. Yes, market fluctuations, economic events, and even fat fingers can all cause your 401(k) to dip, but those dips are temporary. If your 401(k) is losing money, it doesn’t mean your financial future is doomed.

Let's dive into the reasons why your 401(k) may be losing money and what you can do to keep your retirement plans on track if you find yourself in turbulent waters.

Why Your 401(k) Is Losing Money

When your 401(k) takes a significant hit, the first question to ask is why.

A 401(k) is an employer-sponsored retirement account with pre-tax contributions, often matched by your employer, which is a fantastic boost for your savings. But the majority of a 401(k)’s growth potential comes from the ability to invest those savings within the account.

Your 401(k) can include stocks, bonds, mutual funds, index funds, and ETFs. Stocks offer growth potential but come with higher risk. Bonds provide stable returns but lower growth. Mutual funds are managed by professionals, index funds track market indices, and ETFs give you diversification similar to mutual funds but in an easy-to-trade package. When the market dips, so does the value of these investments.

Several factors can stir up the market, causing it to fluctuate. Political developments, like elections, can impact investor confidence and market performance. Economic factors, such as unemployment rates, inflation, and recessions, also play significant roles. And then there are industry-specific trends. For example, shifts in technology or healthcare sectors can ripple out to affect the broader market.

But here's the thing about market downturns — they're influenced by a myriad of factors and, therefore, are often unpredictable. Even so, sometimes your portfolio’s dropping value has less to do with the market and more to do with you.

Your portfolio is down, but so is everything else.If investments are down in almost every category — like we saw at the end of 2018 — and your 401(k) is experiencing a similar drop, that’s normal. There really isn’t too much you can do about it other than keep a long-term perspective and stay the course. Keep in mind that while those dips can be scary, they're usually temporary. The market has a historical record of growth, so patience is key.

Your portfolio is down because you didn’t diversify.Sometimes when we pick our portfolio allocations, we forget to make sure we’re diversifying across industries and asset classes (think domestic and international stocks, bonds, etc.) to balance risk and reward. Maybe you wanted to turbocharge your growth, so you over-allocated into small-cap funds and growth funds, two categories that can have a lot of overlap. If an industry that belongs to both groups takes a dive, your portfolio could see an oversized drop.

Your portfolio is down because you’re doing too much.Study after study has shown that the average investor is bad at timing the markets. And yet, people try to do this all the time in their 401(k), often selling low and buying high again and again, hacking off chunk after chunk of their nest egg. This always reminds me of people who keep trying to “pick” the “fast” lane in 5 o’clock traffic. By the time they get to the lane that was just moving, it’s already stopped and their original lane has started to pick up.

Actions to Take if Your 401(k) Is Losing Money

Now, you hopefully have a better idea why your 401(k) is losing money — but what should you do about it?

Like almost everything related to retirement (and honestly, personal finance), the answer will depend on several personal variables, like your investment timeline, risk aversion, growth goals, etc. However, there are a few rules of thumb that apply to almost everyone in this situation.

Don’t Panic Sell. The worst thing you can do in this situation is panic sell. This locks in losses and robs you of the chance to benefit from a market rebound.

Unfortunately, this is exactly what John did back in 2018. Despite my advice, John moved his entire 401(k) into cash at almost the exact market low of the year. And do you know what he did next? Nothing.

For a variety of reasons, John still hasn’t moved his 401(k) back into stocks, which is a real bummer, as the S&P 500 has more than doubled in the five years since.

Trust That the Market Will Ultimately Recover.Every time the market has dipped, corrected, and even crashed, it has eventually come roaring back stronger and higher than ever. History has shown us that those recovery times can even be relatively short. Nearly half of all market corrections or recessions recover in eight months or less.

Just look at what happened during the COVID-19 pandemic — the market took a nosedive in March 2020, but by August, it had bounced back to new highs.

The stock market is like a living, breathing entity, with its own set of highs and lows influenced by a mix of economic and political factors. Falling prices are just part of the natural order. Fortunately for investors, the typical bear market lasts about 10 months while bull markets tend to last much longer — about 34 months on average.

Do Keep Your Investments Diversified.Keep your money spread across multiple stocks, funds, bonds, and other investment assets. If your entire 401(k) is invested in a single fund and it drops, you'll face much bigger losses than if it represented only 10% of your portfolio. The best way to protect your 401(k) from losing money is to avoid over-investing in any single industry, fund, or asset class.

Do Keep Dollar-Cost Averaging.This is a fancy term for investing a fixed amount regularly, regardless of what the market is doing, which studies have shown can help smooth out the bumps over time. Yes, sometimes you’ll be buying at the highs, but other times, you’ll be buying at the lows.

Do Talk to a Financial Advisor (Especially If You’re Close to Retiring).If you're unsure about what to do or the market crashes when you’re only a few years away from retirement, please consult a certified financial advisor. A financial advisor can help you analyze your portfolio and make adjustments to optimize the right strategy for you. As you get closer to retirement, it might be wise to shift your allocations to help you reach your goals. They can also advise you on other retirement vehicles that could benefit you.

Dealing with a losing 401(k) isn't fun, but it's part of the journey. Declines in your account's value don't mean actual losses unless you sell your investments; staying invested, staying diversified, and consulting with financial advisors can help you navigate these rough patches.

Remember, building a strong retirement nest egg is a long-term game, and market volatility is just one of the many challenges you'll face. Keep your eyes on the horizon, stay the course, and you'll be better equipped to reach your retirement goals.