Tips To Keep Your 401(k) Healthy

A lot of investors are now opening their June statements and panicking.

In 1999, the average balance in 401(k) plans was $46,740. As of June 30, 2002, if your 401(k) was comprised of stocks in the Nasdaq composite, the average valued dropped to $16,826. Why? The Nasdaq composite is off 64 percent from 1999. In addition, assuming an 8 percent return, it would take more than 13 years for you to recoup those gains.

Similarly, if you had a 401(k) comprised of S&P 500 stocks, your portfolio as of June 30, 2002 would have dropped to $31,783 as the S&P 500 index fell 32 percent. Assuming an 8 percent return, it would take more than five years to make up for those losses.

Here are my tips for a healthy 401(k).

1. Re-balance Your 401K

Remember to maintain your long-term perspective. Even though everyone is scared to death of equities, there is good reason to believe stocks will be trading at higher prices than they are trading today. Historically, bull markets always follow bear markets. The S&P is down again this year and is threatening a third down year in a row. The last time this happened was in 1939 at the start of World War II. It logically follows that the odds of a fourth losing year are slim.

Here are the 401 k) allocations that I suggest, based on age:

30s and younger: 100 percent stocks 40s: 80 percent stocks and 20 percent bonds 50s: 75 percent stocks and 25 percent bonds 60s: 70 percent stocks and 30 percent bonds 70s and older: 50 percent stocks and 50 percent bonds

This is the identical asset allocation I suggested last March on Good Morning America. I do not believe the allocation should shift because of recent market volatility. While I am biased towards stock investments, I have always counseled diversification across different types of stocks, which mitigates risk. To that end, make sure you are not over weighted in company stock and that your equity diversification is comprised of a variety of mutual funds instead of individual securities.

2. Use Alternative Sources of Income

Draw on assets outside of your 401(k) plan and take Social Security first to allow your 401(k) plan more time to heal tax-deferred.

Another option is to trade down to a smaller home. If you are 62 or older, consider taking out a reverse mortgage. A reverse mortgage lets you tap into home equity and repay the loan with proceeds from the eventual sale of the property — often at death.

3. Don't Be Too Conservative

Ignore the doom and gloom and don't hit the brakes on your retirement plan. Though it may seem tempting, this is not the time to move your 401(k) money to a money market/cash fund. There is never a good time for that.

The typical money market fund barely outpaces inflation. More specifically, the typical money market fund has returned 5.0 percent per year versus approximately 3.1 percent for inflation. If you put $5,000 in a money market fund each year, you would have $66,034 in 10 years, less $10,500 which would have been eaten away by inflation, leaving you with a total of $55,534.

But if you put that $5,000 a year into a stock mutual fund (returning 10 percent a year) you would be looking at an overall value of $87,656 which is $73,501 after inflation. When investing in the stock market, a certain degree of risk is rewarded.

4. Market Timing Does Not Work

If you were out of the stock market for the best 15 days of the 5 years between year-end 1995 and year-end 2000, you would have been better off investing in a plain vanilla money market fund. This was a period when the S&P 500 averaged more than 18 percent. The lesson? Do not stop contributing. If you sit out and wait for the market to improve, you might miss the best performance yet.

5. Slash Spending and Save More

This is gut check time. If you eliminate just $25 from your budget every week, you would save $1,200 a year. If you invest that same $1,200 in a stock mutual fund every year ($100 a month), assuming an average gain of 8 percent, in 10 years you would have $18,295.

6. Consider Working Longer or Working in Retirement

Assuming you can stay on at your job and continue to contribute to your firm's retirement plan, just five extra years of putting the max into your 401(k) can add an additional $100,000 to your nest egg, assuming an 8 percent return.

7. There Is Still Time

Obviously, the younger you are, the more you benefit from compounding and the more time you have to ride out the volatility of the stock market. That said, if you live past 65, your life expectancy is still another 20 years. This gives your 401(k) investments ample time to recover, and if necessary, it affords you the option of a few more years of work. In fact, more than 50 percent of the population will be working past the age of 65.

To use our calculators to do your own retirement planning calculations, click here.

Mellody Hobson, president of Ariel Capital Management in Chicago, is GoodMorning America's personal finance expert. Click here to visit her Web site, Ariel Mutual Ariel associate Matthew Yale and Ariel's Director of Corporate Communications Anne Roche contributed to this report.