4 ways to recession-proof a 401(k)

By Tim Middleton

Usually at this time of year, investors are "playing the bounce": buying stocks that got dumped for tax losses in December but otherwise are sound.

Don't fall into that trap in 2008. The only thing bouncing around in this market is a bear. We're in a recession, and in a recession, stocks go down. That includes foreign and emerging-markets stocks.

So how do you recession-proof your 401(k)? Here are four distinct strategies that range from helping you lose less in this downturn to helping you make more. Some can be hard to implement in a company plan with relatively few investment options. If that's your situation, use other accounts you own -- individual retirement accounts or a taxable account -- to implement the hedges.

The usual defense: Bonds

This is the simplest and most easily implemented strategy. Swap out of some of your riskiest stocks, such as emerging markets and real-estate investment trusts, and use the proceeds to bulk up on bonds.

• Talk back: Are you worried about the bear market biting into your 401(k)?

"We like bonds because we think the Fed has a lot more rate cuts ahead," says Mark Kiesel, the head of the corporate desk at bond megashop Pimco.

Pimco predicted early last year that the federal funds rate would fall to 4.5% by New Year's Eve. It was a radical projection then, when the rate was 5.25%, but in fact the rate finished at 4.25%.

This year, Kiesel says, "We think the Fed will end up at 3% or even lower, and that will be good for bonds, particularly short-maturity bonds." In retirement accounts, the choice is an intermediate-term, high-quality fund such as Pimco Total Return (PTTRX), by far the world's largest bond fund. Every retirement plan offers a portfolio like this, which this year is likely to deliver returns in the high single digits or better.

A trickier defense: Dividends

Dividend-paying stocks are a traditional defense against downturns because their yield -- the money they pay out to investors -- gives them bondlike attributes. The problem is that dividends are not particularly lush anywhere in the U.S. stock market. iShares Dow Jones Select Dividend Index (DVY, news, msgs), an exchange-traded fund, plunged 10.3% in the three months ending Jan. 16, a bit more than the S&P 500 Index ($INX).

But many actively managed equity funds with "income" in their name have done a better job. A good example is Thornburg Investment Income Builder A (TIBAX), down 7.7% in those same three months, much less than the S&P 500. The current yield is about 4%, and it comes from a blend that is 37% U.S. stocks, 48% foreign equities and the balance in cash and bonds.

"In the United States, investors have bought the bill of goods that either you ask for dividends or you ask for growth," says Brad Kinkelaar, a co-manager of the fund. "It hasn't been that way in many parts of the world, and we believe we can provide both."

The fund's largest holding is Telefónica (TEFOF, news, msgs), the biggest phone company in the Spanish-speaking world. "Regardless of how the U.S. economy does, their customers are going to be using their cell phones," Kinkelaar says. "They are perfect for this type of environment."

Continued: An offensive position

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