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  • Social Security is insufficient for many Americans.
  • Retirees rely heavily on retirement savings to bridge the gap between income and expenses.
  • Bear markets allow you to buy the stock market on sale, potentially increasing long-term returns.

Stocks historically go up and to the right, but they don’t do it in a straight line. Inevitably, there are corrections and bear markets like we’re experiencing now. When the market retreats, contributing more to retirement plans is one thing that long-term investors should consider.

Unfortunately, too few take advantage of lower prices when the market goes “on sale,” making it harder to achieve their long-term goals.

Why retirement plans?

Social Security is designed to replace only about 40% of the average person’s pre-retirement income. Unfortunately, that’s not enough money to support many retirees, so they fall shy of achieving the lifestyle they had hoped for in retirement.

According to the Social Security Administration, Social Security represents over 50% of monthly income for over one-third of men and 40% of women. The ratio is even higher for singles, many of whom rely on Social Security for over 90% of their income. Retirees receive annual cost of living adjustments, yet the average retired worker still pockets just $1,827 in monthly Social Security benefits this year – hardly a windfall considering average annual expenses for Americans aged 65 and up were $48,872, according to the Bureau of Labor Statistics.

As a result, retirees need other income sources to compensate for the shortfall between Social Security income and expenses. In some cases, a pension bridges the gap. However, pensions have become increasingly rare, so retirement plan savings make up the difference for most.

Specifically, retirees lean heavily on workplace retirement plans, including 401k and 403b plans. Fortunately, most employers offer these plans to employees, and they’re particularly valuable because they have a higher annual contribution limit than a traditional or Roth IRA. Self-employed workers often use SEP-IRAs to save for their retirement because they similarly have a high contribution limit.

In 2023, workers can contribute $22,500 to their 401k or 403b plan, up from $20,500 for 2022. SEP IRA contributions can total the lesser of 25% of compensation or $66,000 for 2023, up from $61,000 in 2022. If those options aren’t available, or if your income qualifies, you can contribute up to $6,500 of earnings to a traditional or Roth IRA, up from $6,000 last year.

What makes retirement plans so valuable is that contributions to these plans are tax-advantaged, so more money can compound annually. Contributions to Roth accounts are made with after-tax dollars, but they grow tax-free. Traditional IRAs and retirement plans are funded with pre-tax money, so taxes are deferred until money is withdrawn in retirement, often at a lower tax rate than when the individual was working.

Earning interest on interest, or compound returns, on more money because of these tax advantages makes them incredibly attractive for long-term savings.

A good time to systematically buy stocks

It’s tempting to think that you can time the market perfectly. However, stocks top and bottom before the economy, so many investors mistakenly buy too high and sell too low because of extrapolation bias, the tendency to overweight recent events when making decisions.

Investors who contribute regularly to a retirement plan via periodic installments are less likely to fall victim to this bias, though.

Investing a pre-specified amount of money regularly, or dollar-cost averaging, means you’re buying fewer shares when prices are high and more shares when prices are low. As a result, investments during bear markets, when stock prices have fallen, lower an investor’s average cost, providing opportunities for greater gains over time.

While it’s historically true that every bear market has preceded new highs on the S&P 500, many investors shy away from stocks during bear markets. In effect, these investors short-change their financial future because they ignore the chance to lower their average cost. This can hamstring returns while slowing how quickly account balances rebound.

For example, let’s suppose an investor bought $10,000 of the S&P 500 ETF SPY on October 31, 2007, then dollar cost averaged $100 monthly at month’s end through 2012.

Altogether, $16,200 was invested (the initial $10,000 plus $6,200 in additional monthly contributions), resulting in 154.36 shares. At a dividend-adjusted price of $104.95 on December 31, 2012, those shares would’ve been worth $18,212, a 12.4% gain.

Alternatively, let’s assume she had invested the same $10,000 on October 31, 2007, but added $100 monthly to a shoebox in her closet instead. She still set aside $16,200. However, she barely broke even. The savings totaled just $16,448, about 10% less than if she’d continued monthly investing in the S&P 500.

It’s not hard to imagine how much larger her portfolio would be if she had contributed even more money to her retirement plan during the Great Recession.

The Smart Play

Extrapolation bias is dangerous and hard to resist. We tend to weigh recent events more than past ones, making decisions more likely to reflect short-term headlines than long-term thinking.

Instead, zoom out and remember your long-term investment goal. Was your financial plan structured to provide you with the best shot at achieving the retirement you want? If so, changes based on inevitable bear markets and corrections could prove short-sighted.

Remember, stocks perform best at the beginning of a bull market. The S&P 500’s average return in year one of a bull market is 38%, far better than the 6% average annualized returns over rolling 10-year periods, according to CFRA. The more money invested during the bear market, the better able to take advantage of those robust first-year gains, and the more likely account balances will rebound back to pre-bear market highs faster.

Of course, individual stocks may never recover to past highs, but historically, every bear market has been a good buying opportunity in the S&P 500 index. Why? Because the S&P 500 is a momentum index that only owns the biggest stocks. The index allocates less money to stocks as they decline, eventually replacing stocks if they get too small. As a result, buying the index is very different than buying individual stocks during a bear market.

It pays to sell the first half and buy the second half of a bear market, but nobody rings a bell signaling half-time. As a result, dollar cost averaging can be the best way to take advantage of discount prices during a bear market.

Since retirement plans provide tax-advantaged savings, allowing more money to compound over time, now is the perfect time to reconsider your retirement plan contribution rate. Increasing your rate by even a percent or two during a bear market could be the difference between living how you want to or struggling financially in retirement.

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