5 new rules to end your 401(k) crisis

By Tim Middleton

Buy and hold, that patient practice of tucking money into your retirement plan and hoping for the best, may have cost you 40% of your 401(k) in the past 15 months.

So maybe it's time for you to consider buy and sell. You can't just be a 401(k) saver. You have to be a 401(k) investor.

Self-directed plans such as 401(k)s have all but replaced conventional pensions, which guaranteed you a set income for life based on how long you took part.

It's not because 401(k)s are better -- it's because they're cheaper for employers.

In fact, they have nothing in common with professionally managed pension plans. Individual plans are too small and short-lived to ride out more than one category 5 bear market in a lifetime, and we have had two in the past eight years. The market is down more than 40% from its peak in October 2007.

So the kind of patient, long-term diversification that has proved so successful in the pension industry is proving to be a poor model for these weak little cousins. With some trillion 401(k) dollars lost to this bear market (read "Do 401(k) plans still make sense?"), Congress is talking about everything from a little tinkering to what amounts to a super Social Security plan to head off a crisis. But who knows how long that will take or what they'll come up with?

In the meantime, we can take steps to solve our own 401(k) crisis.

What we need are new rules tailored to today's unprecedented events. Investing, including retirement investing, needs to become less strategic and more tactical.

• Talk back: Do you think you'll have enough to retire?

And investors need to take advantage of the new weapons forged to fight today's battles -- weapons that 401(k)s may not even allow. Shorting stocks, the most successful tactic in 2008's market, is expressly forbidden. Trading frequently is, if not forbidden, punished with fees. The cheapest, most flexible investment choices -- exchange-traded funds, or ETFs -- are almost never available via 401(k)s.

Here are five new retirement-investing rules:

1. Invest less in your 401(k)

The first commandment of 401(k) plans -- thou shalt max out thy contributions -- is the first one you'll need to violate if you want, not merely to retire comfortably, but to retire at all. Instead, you'll need to use a host of accounts, including a conventional taxable brokerage account.

It's not as daunting as it sounds. Thinking beyond the 401(k) and beyond the buy-and-hold pension assumptions upon which it is based simply requires adopting a different mind-set -- and not an original one. Two of the greatest modern investors, Peter Lynch in stocks and Bill Gross in bonds, preach putting your money behind your best ideas, not diversifying it across some consultant's broad matrix of investments.

Even in the miserable climate of 2008, plenty of investors made big money. They just didn't do it in 401(k)s.

So set aside the notion that you should save all you can in a 401(k). Contribute enough to earn your company match -- that's free money none of us can pass up -- and then start looking elsewhere.

2. Start other retirement accounts

The 13 best-performing funds of 2008, according to Morningstar, were inverse-leveraged ETFs, such as ProShares UltraShort Semiconductors (SSG, news, msgs), which soared 114%. No. 14 was the Grizzly Short Fund (GRZZX), up 73.7%. These funds short the market, which means they bet stock prices will go down.

Only the largest, most sophisticated 401(k) plans allow participants to buy individual securities such as ETFs, and virtually none offers bear market (or short) mutual funds. Grizzly Short has total assets of $162.2 million, which makes it one of the smallest funds in the industry. I'd bet you won't find it in any 401(k).

• Video: Market's crash forces many to rethink retirement

To gain access to innovative investments like these, you need an account with a broker.

The first place to look is at tax-deductible individual retirement accounts. You may or may not qualify for one; your employer's human-resources department can answer that question. As with a 401(k), you get the benefit of making tax-free contributions, but you can open it at a brokerage firm -- giving you full access to ETFs and other nontraditional investments.

The second place to look is a Roth IRA. You pay taxes on your contributions, but the qualified withdrawals down the road are not taxed at all. With other retirement plans, you get the tax break now, but proceeds are eventually taxed as ordinary income. In a regime of low income taxes, this distinction doesn't matter much. But from here, income taxes seem destined to rise, at least until the next Ronald Reagan comes along. Roths will be more valuable assets 10 years from now than they are now.

Roths come with income limitations laid down by the Internal Revenue Service. If you don't qualify, another alternative is a variable annuity. These insurance products are expensive, but they have tax advantages and no income limitations. If your income is well into six figures, they can be very appealing.

Continued: Smart tax moves?

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