Planning now can help rescue 401(k) plan

The past three months have been so bad for mutual fund investors that it's hard to look away. But a big part of investing is looking to the future — and, if you take a few steps now, your 401(k) retirement plan should be in the recovery room soon.

Let's start by surveying the damage. Stock funds fell 11% in September alone, the worst month since August 1998, says Lipper, which tracks the funds. Diversified U.S. stock funds fell 10% for the three months ended Sept. 30. A full 87% of all funds showed a loss in the third quarter.

Some of the heaviest losses came in two areas that investors traditionally view as portfolio hedges.

•Gold funds plunged an average 30.7%. Gold itself started the quarter at $930.25 an ounce and finished September at a 6% loss. Most gold funds, however, invest in gold-mining stocks, not the metal itself. And the prices of gold mining stocks reflect investors' views about the future price of gold, not the current price.

•International funds were crushed. The average large-company core international fund plunged 20.9% in the fourth quarter, slammed by a one-two punch of dreadful overseas markets and a rise in the value of the U.S. dollar.

Foreign markets typically plunge when the U.S. stock market falls, and this time was no exception. The Europe, Australasia and Far East index tumbled 13.6% in the third quarter, vs. 8.9% for the Standard & Poor's 500-stock index. The rise in the dollar just made things worse. When the dollar rises, the value of U.S. investments overseas falls. When you take currency conversion into account, EAFE fell 21.5%.

Finally, those who were betting on $200-a-barrel oil didn't count on how badly the prospects of a recession would hurt the oil market. Natural resources funds, which invest mainly in energy stocks, plunged 32.7%, while global natural resources funds tumbled 33.3%.

For many retirement investors, a 10% loss is nothing to be sneezed at. The average diversified fund is down 21.5% the past 12 months — a significant drop for any portfolio. What can you do to repair the damage?

•Avoid specialty funds. In most cases, chasing the white-hot funds will backfire. For example, Russia's stock market soared last year. But the Market Vectors Russia fund tumbled 47% in the past three months. Similarly, funds that rise when the stock market falls — so-called bear funds — have soared 9.2% this quarter. When the stock market rises again, however, they will once again be in the basement.

•Diversify. Let's be honest: The only diversification strategy that worked well in the third quarter was adding money market securities to the mix. Even target maturity funds, which invest in a mix of stocks, bonds and money funds, had problems. Target maturity funds aimed at those who will retire in 2020 fell an average 9.6% in the second quarter — not much different from the average fund's loss. In part, that's because many target maturity funds diversify internationally, a move that only worsened stock returns this year.

But diversification usually works. Don't let one rotten quarter send you fleeing to a bank CD paying 2%. At that rate, you'll double your money in 36 years.

•Plan. There's no perfect general rule for determining how much you should have in stocks, bonds and money market funds.

The most frequently cited rule — the percentage of your portfolio in bonds should equal your age — is problematic for the young and the old. People with more than 20 years to retirement should be 90% or more in stocks; people age 80 can probably keep 30% in stocks.

Nevertheless, it's a starting point. Pension funds typically consider 60% stocks and 40% bonds to be a reasonable mix. But your allocation will also depend on your risk tolerance. If 80% in stocks keeps you awake at night, dial back to 70% and see if you feel better.

Want more help? Several fund companies, including T. Rowe Price, Fidelity and Vanguard, offer very good online retirement planning tools.

•Rebalance. Once you've set your allocation, check it every few months to see if your portfolio is still close to your targets. If it's not, move your money from your winning investments into those that have lagged, bringing your portfolio back to its original allocation. For example, suppose you had resolved to be 60% in stocks and 40% in bonds. Because of the bear market, however, you're now 50% in stocks and 50% in bonds. You'll have to sell enough of your bond funds to get back to 60% stocks and 40% bonds.

Because stocks and bonds often move in opposite directions, you won't have to rebalance often. Rebalance only when your portfolio is 5 percentage points off from its target.

•Save more. You can't control what the stock market will give you, but the single biggest factor in the size of your nest egg is the amount you save. Odds are good that you'll barely notice it if you contribute 1 percentage point more of your salary to your 401(k) plan.