What to Do with Your 401(k) Now

Get the Big Picture

This first step is the one most commonly ignored or skipped,
says Neil Goldberg, a principal with Boston-based investment advisory firm GW &
Wade. Examine all your financial statements, and put your 401(k) in
perspective with your overall wealth picture. How can you know what you need to
do if you don’t know what you have? “We see this a lot:
People look at their 401(k) as a standalone, siloed part of their assets,”
says Goldberg. “But if financial advisers are doing their jobs, they’ll
have you look at the broader context.”

How does the 401(k) look when compared to other portfolio
holdings, IRAs, accumulated cash, real estate, and so on? If you’re
robust in those other areas, your 401(k) isn’t as crucial a component
as it is for someone with no savings at all. Now that you know what you have,
you can figure out what you need.

Find the Right Dollar Amount

It’s very easy to be arbitrary when you’re
asked how much you think you need to save for retirement. “Oh, maybe
$2 million. Five would be great.” Well, if $5 million, why not $4.8
million, or $5.25 million? Time to admit a core problem: You don’t
know.

Retirement and 401(k) calculators abound online, and for good
reason: They work. T. Rowe Price has a href="http://individual.troweprice.com/public/Retail/Planning-&-Research/Tools-&-Resources/Retirement-Planning">good
one. Based on the calculator’s magic, and paired with the big-picture
information from step one, you should now know how much you need to put away to
guarantee the retirement you want.

Is it a bigger number than you thought? Don’t ignore
it or shrug it away as unrealistic, says Frank Armstrong, founder of Investor
Solutions in Florida and author of Save Your Retirement: What to Do If You
Haven’t Saved Enough or If Your Investments Were Devastated by the
Market Meltdown. The number is not a lie. It’s what you’ll
need based on the criteria you yourself put forth. Now it’s time to
save. Start by bumping up your 401(k) savings by as much as you can possibly
afford (at least go beyond the percentage that the company will match). You may
need to cut back in other areas. Don’t fret over it, just do it.
Because the bottom line still stands: People do not save enough.

Allocate Intelligently

This step requires you to make a decision, and choices stress us
out: A 2008 University of Minnesota study shows ― as have others ―
that facing too many choices, and trying to make them, is painful, mentally
draining, and can lead one to agonize over perfection when good is good enough.
So if you have no time (or inclination, or better excuse), go online right now,
boost your savings percentage, and divert the money into a target date fund.
(If your plan doesn’t offer such a fund, put half in an equity index
fund and half in a short-term bond fund. That allocation isn’t
perfect, but it’s better than nothing. You can tweak it later.)

Target date, or lifecycle, funds take the guesswork out of
choosing from investment options you may not understand yet get you allocated
in a basic, appropriate way immediately. “This can work as a passive,
throw-up-your-hands investment for those who don’t have the ability
or time to manage their 401(k)s,” says Steven Keirn, a colleague of
Goldberg’s at GW & Wade who specializes in comprehensive financial
plans. But he stresses that this is a basic choice, not optimal.

For optimal results, start with these age-appropriate
allocations:

• 20s: As high as 80 percent equities, 20 percent bonds. “You
  simply have time on your side,” he says.
• 30s: Ratchet back to 70/30, he says. In theory, a
  thirtysomething person is marrying, procreating, and buying a home, but still
  has a good 30-year horizon to absorb market ups and downs.
• Late 40s, early 50s: From 65/35 to 60/40. “The shift
  to bonds as you approach retirement gives you keel on the boat,” he
  says.

Personalize his suggested allocation by factoring in your own
risk tolerance. Don’t trust what you think your risk tolerance
is, though. Use an online questionnaire such as href="https://personal.vanguard.com/us/FundsInvQuestionnaire">this one from
Vanguard.

Next decision: To allocate the stock portion of your portfolio,
Keirn suggests putting 60 percent in big company stocks, 25 percent in mid-cap
stocks, and 15 percent in small-caps. Also, pay attention to your domestic/international
splits, with 30 to 40 percent in international stocks, including emerging
markets. “For the foreseeable future, the U.S. economy will probably
not be the main driver of global asset growth,” he says, “and
a lot of that growth will come from emerging markets.”

This should go without saying, but don’t even try to invest based on a guess about what the market will do next. First of all, no
one knows. Second, it’s irrelevant, since you’ll be
investing every two weeks for many years in good markets and bad markets. Tune
out the noise.

As you close in on retirement, however, you have to pay strict
attention to liquidity ― how much cash will you need and how soon? “It’s
useful to look at what Harvard and Yale did with their endowments,”
says Goldberg. “They had very little liquidity going into the crisis,
and they had to sell at losses to gain liquidity just to run their operations.
Substitute yourself for Harvard. If you don’t have liquidity to cover
your first few years in retirement, you must manage your portfolio in general,
and your 401(k) specifically, with an eye toward that.” Here’s
where cash and bonds make sense. Once you approach retirement, but are still
working, Keirn recommends stockpiling at least a year’s worth of annual
expenses in cash. Once you retire and no longer have income, boost that to two
years, which you replenish so you always have that minimum two-year cash
cushion as you go. In years where the stock market does well, increase that
cash cushion, so you don’t have to sell in bad years.

Choose the Best Funds

Here’s where Step 1 comes back into play. Knowing how
your 401(k) plan fits into your big financial picture will determine how to
choose mutual funds within your employer’s plan, says Goldberg.

The key is to balance your 401(k) investments with other
investments to make sure you are properly diversified and making the best of
each account. Example: If you have an IRA, you’ll have far more investment
choices in that account than you do in your 401(k). So, you might use your 401(k)
to invest in two plain vanilla offerings ― a Standard & Poor’s
500 index fund and a short-term government bond fund. Then you can round out
your overall asset allocation by using your IRA to invest in an international
fund, a small-cap fund, and a corporate bond fund. As for choosing funds, href="http://www.morningstar.com/">Morningstar ratings are a great source
of information. In all cases, href="http://moneywatch.bnet.com/investing/article/mutual-fund-fees-jump-5-percent/331641">keep
your fees as low as possible: If you can save one percentage point in fees,
you’ll keep $5,000 a year for every $500,000 in your portfolio. Big
money.

The secret to retiring comfortably? Diversify, keep your fees
low, and save till it hurts.