Saving for Retirement

Protect Your 401(k) in Turbulent Times

Don't be tempted to stop saving or cash out your retirement accounts. Take these four steps instead.

By Cameron Huddleston, Contributing Editor, Kiplinger.com

October 1, 2008

A solid, long-term strategy that involves a well-diversified investment portfolio should protect your 401(k) or other retirement account during rough times, Brodeski says. For example, if you have weighted your portfolio too much toward a certain stock or sector, realize you will have to wait longer to see your account recover.

If you don't have a plan, start by testing your risk tolerance. Then figure out how much you need to save for retirement, and calculate how much to set aside each month to reach that goal based on an average annual rate of return. Knowing these things will help you select investments for your retirement account.

If you're young, your 401(k) portfolio should hold almost entirely stock funds. Stocks carry greater risks but also greater returns than bonds and money-market funds. Make sure you diversify, though, among funds that invest in stocks of large, small, domestic and international companies, as well as growth stocks and value stocks.

Even if you're close to retirement, you should have 70% to 90% of your retirement portfolio invested in stocks or stock funds, says Brodeski. You still should have at least 60% to 70% in stocks when you're retired. That's because most of your portfolio should be invested to carry you through your retirement years. Any money you figure you need over the next few years, Brodeski says, should be in cash and safe assets -- an insurance policy for when stocks are down and you don't have to sell at a loss.

For more about creating a diversified portfolio that's appropriate for your time horizon, see our suggested portfolios using the Kiplinger 25 best mutual funds and Build Your Perfect Retirement Portfolio. Or consider a target-date retirement fund, which handles the diversification for you and shifts asset allocations for you as you near retirement.

Take that deep breath. If you stop contributing to your retirement plan now, you'll miss out on compounding -- that wonderful phenomenon that lets you generate earnings from your investments' previous earnings. And you could miss out on free money if your employer matches your contributions.

If you panic and cash out your account entirely, you'll have to pay a 10% early-withdrawal penalty if you aren't 59½. Distributions, regardless of your age, are taxed as regular income. Plus, people who pull their money out of the market in a panic not only sell at the wrong time, they often buy back in when prices are too high, Brodeski cautions.

Instead, use this recent market volatility as a wake-up call. "Every investment plan -- even a 401(k) -- requires periodic maintenance," Bergquist says. "If you are not invested in something like a target fund that automatically reallocates your retirement portfolio, now is probably a good time to make sure you are allocated properly." Picture yourself at retirement time if the current volatility occurs again: Would your portfolio be positioned to handle it?

Ask your employer for help. You don't have to fly solo during these tough times. Thanks to a change in the law in 2006, employers can now provide investment advice to employees who participate in 401(k)s and similar plans.

So check with your employer to see if your plan administrator can offer guidance. A recent Charles Schwab survey found that 401(k) investors who used some type of plan-offered advice earned annual returns about 3% higher than do-it-yourselfers, Bergquist says. "This can make an even bigger difference in a tough market environment."

Editor's note: This story has been updated since it originally was published in January 2008.

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