Don't get risky with late retirement saving

NEW YORK (Money) -- Question: I'm 55 years old and have saved only about $15,000 for retirement. Realizing I've started very late, I now set aside 10 percent of my income in my 401(k) plan. How much of my portfolio should I allocate to bonds? Do I even need bonds since I have so little money to protect? Maybe I should invest aggressively since $15,000 will not last very long anyway. - Jo, Portland, Oregon

Answer: I'm glad you have realized that you're behind in your retirement planning and that you're taking steps to get back on track.

And while I don't want to underestimate the challenge that lies ahead for you, it's also true that even given your late start, you can still dramatically improve your situation.

That said, I also have to tell you that your main focus should not be on investing more aggressively. Failing to save for retirement for much of your career isn't a problem you can invest your way out of.

Sure, it would be nice if there were a "Make Up For Lost Time Fund" that delivers high returns with low risk to people who procrastinated.

But in the real world, when you shoot for bigger gains, you take on more risk. Which means that instead of your $15,000 nest egg soaring in value, it could suffer steep losses that would take many years to recoup. That's not a risk you want to take at this point in your life.

So what should you do? I have three recommendations:

You're doing the right thing by feeding your 401(k). But can't you feed it a little more? The poor thing has been starving for years. Stashing 10 percent of your salary into your 401(k) is better than nothing.

But you're in pretty dire straits here. It's time to go flat out here and save as much as you possibly can. So why don't you try challenging yourself and contributing, say, 15 percent. And if you manage that, maybe you can shoot for an even higher figure, say, 20 percent.

If you can't do this all at once, try increasing your savings rate by one or two percentage points a year. Some 401(k)s give you the option of having the plan automatically increase your contribution rate each year.

Yes, cutting back on your spending may be uncomfortable. But don't think of your saving effort so much as crimping your current lifestyle as a way to improve how you'll live in retirement.

You delayed saving for retirement, so it's only right that you be willing to delay your retirement a few years to let the old 401(k) grow. So if you were thinking of retiring at, say, 65, consider holding off until 67 or even longer. You'd be surprised at how much bigger a nest egg you can accumulate by continuing to work just a few more years.

Let's assume just for argument's sake that over the next 10 years, you plow $500 a month on top of the $15,000 you already have in your 401(k), and let's figure you earn 8 percent a year. At 65 that would give you a 401(k) balance of roughly $123,000. Not bad.

But if instead of retiring, you continued that regimen for three more years, the combination of the returns you would earn on what you've already accumulated, plus your extra savings, plus the return on the extra money you stash away would bring your 401(k) balance to just over $175,000, giving you an extra fifty grand.

Oh, and putting off retirement would also get you a larger Social Security check. (To see how much your benefit might increase, check out the Social Security benefit calculator.)

You've still got a good 10 years or more of investing before you retire. And even then you'll be investing your nest egg for a long time in retirement, likely 25 or more years. That argues for investing most of your 401(k) in stocks.

Notice, though, that I said "most," not "all." You still want a decent slug of bonds in there to act as ballast during market storms. So how much of your portfolio should be in stocks? That depends largely on how much risk you're willing to take, but I'd say 65 percent to 75 percent or so is a reasonable range.

Whatever percentage of stocks you choose, make sure you invest in a broadly diversified stock fund, not some fund that concentrates in feisty small-caps or high-octane tech shares that are likely to swoon at the first whiff of a market setback.

As for bonds, you can get into a whole guessing game of whether to go long or short in maturities, whether to stick with governments or corporates, whether to dabble in high-yield bond funds.

But unless you really know the ins and outs of the bond market - and, in my opinion, not many people do - why bother? A much simpler route is to simply divide your money between a short- and an intermediate-term bond index fund. You'll get plenty of diversification, a decent yield and, if interest rates rise, you'll get more protection than you would with long-term bonds.

If your 401(k) doesn't offer bond index funds, then go with the short- and intermediate choices with the lowest fees. As you get closer to retirement, you should dial back your stock exposure. By the time you retire, you want to be 50 percent to 60 percent in stocks and the rest in bonds. You can continue to pare your stock holdings during retirement.

But even in your late 70's and early 80's you probably want at least 20 percent of your portfolio in stocks, since equities' growth potential can help you maintain your purchasing power.

So there's your three-point plan for salvaging your retirement after years of neglect. Remember, though, the single most important thing you can do is shovel as much as you can into that 401(k). If you don't do that, the other moves will have a marginal effect at best.