Thursday, December 25, 2008

Rebuild retirement savings with 401(k) and smart use of stocks

The bear market and the economic slump have caused most 401(k) retirement savings to have a major meltdown this year.

Not only has the financial mess caused retirement investments to plummet in value, it also has caused a growing number of employers to suspend their 401(k) company match.

But as gloomy as it all seems, you shouldn't spend the winter hiding under your blankets. After you put away your holiday decorations, it's a good time to regroup and learn from this year's pitfalls and mistakes.

Here are some tips for rebuilding your retirement savings in 2009:

Make sure you can sleep at night
FIND MORE STORIES IN: CDs | Enron | Vanguard | Hewitt Associates | Employee Benefit Research Institute | Pamela Hess | Center for Retirement Research | Jack VanDerhei | Christopher Jones | Financial Engines

As difficult as the year was, you may have learned some important things about yourself. You may be far less willing to take risks than you think.

"We've been through one of the most rapid and extreme bear markets in history," says Stephen Utkus, principal at Vanguard's Center for Retirement Research. "And if that wasn't a test of your risk tolerance, I don't know what would be."

If you're still comfortable with your asset allocation, then your risk and return are in a good balance. But if you've lost much sleep this year, you know it's time to reduce your risk and adjust your investment priorities.

Don't panic

After the worst financial crisis since the 1930s, you need to start 2009 by making a candid assessment of your retirement plan, Utkus says. If that means investing less in stocks, fine. Just be aware that you may have to increase your savings over the long term to compensate for the lower returns you'll get from bank CDs and money market funds.

If you shifted money in a panic, however, you might want to reconsider. So far this year, 401(k) trading activity has risen to 6%.

"It's only 6%, but it's very high, relative to other years," says Pamela Hess, director of retirement research for Hewitt Associates. "And there has been a lot of emotional selling."

Not surprisingly, most have moved their money into stable value funds and money market mutual funds. That may seem safe. But if you're planning to get back into stocks, don't think you'll be able to time the market. Most people simply sell low and buy higher.

"They really risk missing the upside," Hess says. "Then they are locking in an inferior return."

Start the year by making sure you have a smart financial strategy — and don't rely on the past when you plan for your future.

"Everyone says, 'The market is going down, therefore I shouldn't invest in equities,' " Utkus says. "You should think about how to be best positioned going forward, as opposed to spending too much time looking out the rearview mirror."

And most planners say that if you have a long-term investment horizon — 20 years or so — you should have most of your assets in stocks.


Some plan participants were too aggressive in their investments by investing only in one kind of stock — small-company stocks, for example. When the market collapsed, their retirement savings did, too.

It's even more risky to be too concentrated in company stock, says Christopher Jones, chief investment officer for Financial Engines, which provides advice to 401(k) plan participants.

Even though the Enron debacle should have provided a cautionary tale about investing in company stock, that's still a major problem, Jones says. Many plan participants continue to invest 100% of their 401(k) money in company stock.

"They look at the stock market and say that they've done better in their company stock," he says. "The fallacy, of course, is that it doesn't guarantee anything about the future."

Make sure that you have a well-diversified portfolio that includes broad-based stock funds, such as those that track the S&P 500-stock index.

"Don't confuse bad investment results in the past with a good financial incentive going forward," says Jack VanDerhei, research director of the Employee Benefit Research Institute.

Be mindful of your age

When you're 30, you can put all your money in stocks because you'll have plenty of time to make up for losses. When you're 55, it's much harder to make up those losses. Many employees who are close to retirement are now suffering because they had overly invested in stocks.

But if they'd invested in a target-date fund, they would be in better shape. These funds invest in a mix of stocks, bonds and money funds based on when you plan to retire, and they're managed by professionals who make disciplined investment plans.

Nearly half of 401(k) plan participants who are ages 56 to 65 had portfolios that had at least 20% more in stocks than target funds designed for that age group did, says VanDerhei.

Many companies now use target-date funds as the default option for 401(k) automatic enrollment — but that generally involves younger employees, who are newly enrolled. Older plan participants should consider moving their 401(k) money into target-date funds, especially if they don't believe they have the financial acumen to accomplish their asset allocation on their own, VanDerhei says.

Keep saving

Even if the stock market calamity has made you feel frightened and demoralized, you should try to stay in the game, Hess says.

Then you can take advantage of the pretax savings that you have in a 401(k) plan. And if your company offers a matching contribution, you also can take advantage of that.

"You should make sure that you are saving enough to get every last penny of your company matching contribution," Jones says.

Unfortunately, more than 20% of the workers who participate in their plan don't contribute enough to get the full company match, according to Hewitt Associates.

Keep the big picture in mind

A growing number of employers are suspending their company match. That creates worries and resentment among workers, And some are considering dropping their 401(k) plan entirely.

But keep in mind that most companies, unless they go into bankruptcy, will eventually reinstate their matching contribution. And the responsibility for retirement savings was yours, anyway, says Sheryl Garrett, a financial planner in Kansas City, Mo.

"Companies have to cut where they think it inflicts the least amount of pain on their employees and their business," she says. "Cutting into your retirement nest egg temporarily is their way of trying to stay viable and continue giving you a paycheck."

Don't cash out

Younger employers tend to cash out their 401(k) plan when they switch jobs. Big mistake.

For most, if they have $10,000 or less in their plan, it looks like free money, and retirement seems far away, Hess says.

But if a 25-year-old has just $5,000 in a retirement account that earns a 7% average rate of return, it will be worth $74,872 when the worker reaches 65 — even without adding any more money, according to Hewitt.

Take charge

Most people are passive investors, Hess says. It would be great if they took a more active role in their savings.

By Christine Dugas, USA TODAY

In the past, many workers had a pension plan, so 401(k) plans were a supplemental benefit.

"Now, they are our main savings vehicle, and so it's important to have a plan and stick with it," Hess says.

If you need help, you should check out the tools and advice that your employer offers, or talk to a financial planner. But start out the year with a good retirement plan.

"Keep in mind that for most Americans, a 401(k) plan is the bedrock of their retirement saving," Jones says.

"You are responsible for making the investments and for bearing the consequences of the investment risk."

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