By Catherine Holahan, MSN Money"Don't panic" is the advice the pros offer investors contemplating year-end adjustments of their 401(k)s.
Given the market's downward spiral this year, it may seem prudent to move all the money in your 401(k) to U.S. Treasury bonds or a savings account. But that's a bad idea, financial planners say. In fact, they recommend investors do just the opposite: Buy more stocks.
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"It is hard to do after an awful year like this, but at the same time, the best way to make back that money is to stay in stocks," says Russel Kinnel, the director of mutual fund research at Morningstar, an investment research and asset management service. "Your goal is to buy low and sell high, and, because stocks are low, the more you can put in the better."
401(k) do's
That's not the only counterintuitive advice experts are giving. Some of the recommended 401(k) moves seem downright irrational. Among other things, the pros suggest that strapped investors actually increase 401(k) contributions, that investors should opt to pay taxes on their 401(k) savings upfront and that investors who've been burned may want to keep that mutual fund manager who did nothing as investments declined.
401(k) don'ts
Buy more stocks -- really
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Kinnel reminds us that winners have a way of turning into losers and vice versa. That's why he suggests that, every year around this time, investors should take money out of the 401(k) funds that performed the best and move it into the funds that performed the worst. This year, that means taking funds from U.S. Treasurys and moving them into stocks.
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Before you stop reading, take a look at his reasoning. Kinnel explains that rebalancing your 401(k) in this way ensures that you don't unwittingly take on more risk than planned -- or miss out on market rebounds -- by allowing too large a percentage of your savings to collect in one investment. After years when the stock market performs well, such rebalancing protects investors against future downturns by keeping their savings spread fairly evenly between relatively risky higher-return assets, including large-cap U.S. stocks, and safer bets, such as bonds. This year, rebalancing ensures investors won't miss out on the eventual market upswing.
"If you don't rebalance, you are going to likely diminish your returns and increase your risk," Kinnel says. "You will end up with something really unbalanced, and when the markets rotate and shift . . . you are going to miss out."
Investors should keep their planned retirement dates in mind when reallocating funds. Those who plan to remain in the work force for a decade or more can afford to have a larger percentage of their savings in more-volatile investments, such as mutual funds that concentrate on high-growth, emerging markets. Those who plan to retire in the next several years should opt for safer investments, such as bonds, to guard against losing money they won't have a chance to earn back over time.
"Make sure that your asset allocation is appropriate for your age and your time horizon," says Barbara Fallon-Walsh, the head of retirement plans at Vanguard, a U.S. investment management company that oversees about $1 trillion in assets.
One way to take some of the guesswork out of this kind of rebalancing is a targeted retirement fund, Fallon-Walsh says. Such plans automatically shift investments from riskier, higher-yield funds to safer, lower-earning asset classes as investors approach their goal retirement dates.
Give your retirement a raise
It may seem wise to sock some money away in a savings account during this recession. With unemployment rising and credit still difficult to obtain for many, it's natural to want the security of knowing your cash is in an easily accessible local bank, not locked up in an investment that could take a dive over the next couple of weeks.
But taking that route risks losing a significantly richer retirement, Fallon-Walsh says. She recommends that investors increase their 401(k) contributions by a percentage point -- about the amount of money they were spending on gasoline when prices spiked earlier this year -- to take advantage of depressed stock prices. If history repeats itself, stocks are likely to recover over the next several years, yielding significant returns for investors, she says.
"It's bizarre, but people tend not to think about stocks and investments the way they think about a car and a house," Kinnel says. "If a car's price is marked down, you are happy and more likely to buy. It should be the same for stocks."
Investors over 50 should add even more to their investments. Fallon-Walsh encourages those nearing retirement to put in so-called catch-up payments of $5,500, the maximum allowed under the law each year.
Pay taxes the smart way
A recession may not seem like the best time to give the government more money. But paying taxes on your 401(k) contributions upfront will make future returns tax-free. Fallon-Walsh recommends that employees opt for a Roth 401(k), if it's available. That way, they won't owe anything on the money they make from the market's eventual recovery.
Historically, the market has returned about 8% a year, on average. So the tax savings on 401(k) earnings can prove significant.
"We have a better chance of getting an 8% return each year after the market has been down 40% than after the market is up 20%," Fallon-Walsh says.
Don't fire your fund manager
It may feel good to think about punishing someone for the declines in your 401(k), but that could turn out to be a big mistake, the pros say. Remember that good performance is relative, Kinnel says. If your 401(k) is down 35%, that's still pretty decent, considering the market is down around 40%, he says.
"When you hire a stock manager, with a few exceptions, you are asking them to pick stocks for you, not to pick markets," Kinnel says. "So don't fire him for not having the foresight to go entirely into cash."
Also, don't judge a fund or its manager by one year's performance. Anyone can have a bad year. Your 401(k) is about investing for the long term. If the historical performance of the fund is solid and you believe in its strategy, then stick with it, Kinnel says.
Don't tie your future to your company's future
Keeping a ton of money invested in your company's stock is probably a mistake, says Fallon-Walsh. Your company already has a huge influence on your financial future, as it determines your salary, benefits and contributions toward your retirement. There's no need to increase that influence -- concentrating your risk -- by tying your financial future even more closely to your company's fortunes, Fallon-Walsh says. Well-diversified mutual funds are a much better option, she says.
"You are not well-diversified if the fund that you have chosen is overexposed to company stock," she says.
Hands off that portfolio
Once you have taken all the recommended steps to ensure a well-diversified retirement portfolio, leave it alone. Don't panic and start to move money around too aggressively, Kinnel says. Not only will you incur fees, but withdrawing your 401(k) funds during downturns and reinvesting during booms does little but increase your risk of missing out on rebounds, he says. Instead, take a deep breath and remember that your 401(k) is a long-term investment.
"The worst thing you can do is try and time the market," Kinnel says. "As obviously tempting as that is today, it is an extremely hard thing to do."
Published Dec. 12, 2008
Produced by Darragh Worland
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