Fund Guide: Assess, rebalance your 401(k) after 2008 losses

The bear market is no abstract mathematical notation, no mere number on a newspaper page: It's a concrete change in your life, and not a good one, especially if you're saving for retirement.

Consider this: If your 401(k) had $100,000 invested in the average stock mutual fund at the beginning of last year, you've lost $39,500, thanks to the worst year for funds since Lipper began tracking them in 1959. You'll have to earn 66% just to get your account back to where it was a year ago.

Losses like that leave a mark, and not just on your willingness to invest in stocks. They can mean a longer work life. A reduced retirement. Or no retirement at all.

"Will this deter us from an early retirement? Oh, yeah," says Katherine Watson, 53, of Bloomington, Ill. "Will I be likely to gamble on the stock market by purchasing an individual stock? No way."

For most workers, investing for retirement isn't optional. It's something you have to do because you won't get a traditional pension. As you survey the smoking wreckage of your 401(k) retirement plan, you're probably wondering: What should I do now?

There's no one correct answer. But to get past some of last year's devastating financial losses, you'll need to make some adjustments. You'll need to work through the psychological effects of your losses. You'll need to make some adjustments to your portfolio. And you may even want to make a few speculative bets on the stock market's recovery. Just be sure you don't speculate with money you'll need anytime soon.

Taking the hit

The first stage in taking a big loss: denial. "My husband, who has been the major breadwinner the past 35 years, refuses to look at his 401(k) status updates," says Watson.

That's normal, says Meir Statman, professor of finance at Santa Clara University. "People check their balances more often when the market is up than when the market is down."

And when people do check their balances, they're not happy, to put it mildly. "It's a depressing feeling," Statman says. "They say, 'I'm a loser.' It's very hard to make peace with it."

Unfortunately, that's just what you have to do. One way to deal with your losses is to realize that you're not that much worse off than everyone else. The bear market savaged Mr. and Mrs. Jones' 401(k), too. And if Mr. Jones claims he moved to a money market fund just before the bear market started? He was probably lucky. "They will probably be wrong next time," Statman says.

Ultimately, though, you simply have to suck it up and move on. Even though stock returns have been wretched the past 10 years — the Standard & Poor's 500-stock index has lost an average 1.3% a year for a decade — your alternatives aren't great, either. For example, an ultra-safe 10-year Treasury note will return just 2.5% a year. At that rate, it will take 29 years to double your money.

Practical steps

How can you repair some of the damage? A few ways:

•Set a fixed allocation between stocks and bonds, and stick to it. If you have 20 years or more to retirement, you can keep most of your money in stocks. Your losses from last year won't hurt as much in 2029.

Keeping 90% of your money in stocks still gives you a cash reserve in case you sense a buying opportunity. Even an 80% allocation is fairly aggressive.

If you have fewer than 20 years until retirement, consider dialing stocks back to 50% to 70% of your portfolio.

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