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A Supreme case for saving your 401(k)

A Supreme Court case underway shows that administrative snafus can undermine your best efforts. Here's how to guard against that.

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By Janice Revell, Money Magazine senior writer

NEW YORK (Money) -- As a current Supreme Court case shows, even investors with the best intentions can lose big when their 401(k) plans mess up. The lesson: You should take advantage of a host of new investments that make sure that never happens to you.

Here's the abbreviated version of the case before the Court: Back in 2000, James LaRue asked his company's 401(k) plan to sell some of his high-flying mutual funds and move his money into safer investments. But the plan failed to carry out his request. The stock market tanked, and by the time LaRue knew what was going on, he was out $150,000.

LaRue's attorneys are arguing that this is a clear breach of duty, while the company says that pension law only allows suits when the administrators' missteps hurt the entire plan, not an individual participant.

It's a toss-up which way the court will decide, say Supreme Court watchers, and a decision is months away.

While we're waiting for the wheels of justice to grind on this question, there's something else about this case I found fascinating and it's this: At the height of the stock market, LaRue decided it was time to take some of his gains off the table.

That alone makes him unique. The truth is, more than 70% of all 401(k) participants never bother to rebalance their portfolios, according to research from consulting firm Hewitt Associates.

By definition, rebalancing means buying low selling high. It's all about setting an appropriate asset allocation - a mix of stocks and bonds - and making sure you stay near that target regardless of what happens in the markets.

It didn't work out for LaRue. You, however, don't have to suffer the same fate. A lot has changed since 2000: a whole range of tools are now available for rebalancing your portfolio that weren't readily accessible back then.

More importantly, you stand to reap a big payoff from rebalancing. Data released last week by Charles Schwab shows that 401(k) participants receiving some type of assistance with rebalancing, either through advice or specialized retirement funds (more on those in a moment) raked in annual returns during 2004-2006 that were about 3 percentage points higher than the returns of do-it-yourself investors.

That is a huge difference. Say, for instance, that you put $10,000 a year into a 401(k) and received an average annual return of 6%. After 30 years, you'd have about $790,000. But bump that return up by 3 percentage points, to 9% annually, and you'd end up with more than $1.3 million.

These days, getting that extra payoff is easier than ever. A growing number of companies are now offering an automatic rebalancing service for workers in 401(k) plans, usually for free. Call your benefits department and grab this option if it is available to you.

Another excellent choice, is to plough your 401(k) contributions into so-called "lifestyle" or "target-date" funds. The lifestyle versions, which typically carry names like "aggressive" or "conservative" funds, maintain a preset mix of stocks, bonds, and cash - when that mix gets out of kilter, it is automatically rebalanced to the original targets.

Note, though, that this preset mix of stocks and bonds doesn't change over time. So as you get older, the onus will be on you to shift to a more conservative fund.

Target-date funds, on the other hand, are truly no-maintenance. You make your choice based on the expected year of your retirement - for instance, if you were buying a fund today and planning to retire in 20 years, you might pick Schwab's 2030 fund. Once you've invested, the fund automatically adjusts the mix of stocks and bonds to more conservative levels as time passes. Almost all the major fund companies have rolled out target-date offerings.

And, of course, you can always tackle the rebalancing job yourself. Ideally, you'd rebalance when your target stock and bond allocations got out of whack by 5% or more. But studies have shown that doing it once a year is just fine.

But if you want to go the DIY route, remember this: it can be mighty tough emotionally to sell some of your winning stocks. And as the LaRue case shows, snafus out of your control might mean you don't get the result you intended.

No matter which option route you choose, rebalancing is a good idea - years from now, you'll be glad you did.

Questions or comments about retirement? Send e-mails to jrevell@moneymail.comTo top of page

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