How To Fix Your 401(k)

If your retirement plan has taken some punishing blows, these remedies can ensure that your golden years aren't tarnished

money out, and you’ll be vulnerable to a 10% early-withdrawal penalty before age 59. In this situation, after you’ve earned the employer match and made a Roth IRA contribution, you might do your other investing in a tax-managed or tax-efficient mutual fund,” says Smith. Tax-managed mutual funds make a special effort to avoid passing tax consequences on to shareholders. For example, if they sell some stocks at a gain, they’ll sell other stocks at a corresponding loss.

4Don’t buy what’s hot. In 2000 and 2001, the top-performing investments have been bonds, value stocks, and small-company stocks. “Don’t load up in these areas,” says Boyd. “That’s the same trap investors fell into before. Large-company growth stocks did so well in 1998 and 1999 that people invested their 401(k) contributions in those stocks, just when they were overpriced and ready to fall.”

Instead, Boyd advocates developing an investment plan, in keeping with your goals and risk tolerance, and sticking to your plan. “Rebalance by making your allocation mix even again. Take from your winners and give to your losers, so you can ‘rediversify’ those areas of your portfolio that are overweighted. This prevents you from taking on a lot of risk,” says Boyd.

Often, your allocation will depend upon your age. Young investors, with decades until retirement, may be confident of earning substantial rewards from equities. “I’m not planning to retire for another 20 or 25 years,” says Brown. “I expect stocks to have the highest long-term returns, so that’s where I’m doing most of my retirement investing.”

Even the most aggressive investors, though, should diversify among the types of stocks they own. “Perhaps 10% to 25% of the equities in your 401(k) should be in funds that buy small
and midsize companies,” says Haywood. Furthermore, advises Elijah A. Faulkner, a financial advisor with American Express Financial Advisors in West Des Moines, Iowa, “Your stock funds should be a mix of value as well as growth issues.”

On the other hand, older investors may be better off with a sizable allocation to bonds. “Anyone within five years of retirement needs to be extremely careful,” says Shote. “We are in uncharted territory, thus I do not want people who are ready to retire to think they should go on this wild roller-coaster ride.”

Haywood says that all the events of the past two years are a signal for investors to go back to a traditional diversified portfolio. “After the bull market of the late 1990s, a lot of people went to all stocks, but you really should hold some bonds, too. Circumstances vary from one investor to another, but you might consider holding 30% of your portfolio in bonds and cash reserves.”

Conservative investors might have fixed-income allocations as large as 60%, according to Williams. “In your 401(k), you should hold both government bond funds and corporate bond funds, if these choices are available,” he says. “Corporate bond funds tend to be riskier, but they may have higher returns, long-term, so younger investors might want to tilt in that direction.”

5Don’t

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