Coping with a late-career bear market

Michael and Linda Smith, with son Jacob.

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NEW YORK (Money Magazine) -- Michael and Linda Smith have suffered through their fair share of lousy markets, and they've always bounced back. After the 2000-02 bear erased 40% of their retirement savings, the East Aurora, N.Y., couple steadfastly stuck to their long-term outlook.

By continuing to contribute to their 401(k)s at work and with the help of subsequent market gains, the Smiths finally recovered fully from those losses.

But then the current bear roared in. With only a handful of years left before retirement, Michael, 55, and Linda, 58, worry that they won't have enough time to make up their losses this time around.

When their 401(k) balances dropped from more than $400,000 last year to about $330,000 this spring, that uneasiness drove them to move half of their money out of equities and into bonds.

The pair even considered dumping their entire nest egg into slow-growing fixed-income investments. "I can't keep losing a couple thousand dollars a week," Michael says.

The Smiths need to keep in mind that while bear markets can hurt a portfolio, how you react to downturns can make matters worse, says Allan Roth, a financial planner in Colorado Springs. He points out that investing in stocks when they're hot and then running to bonds when they're not has a name: performance chasing.

"When you move in and out, you're actually increasing risk while decreasing your returns," Roth says. Over time, market timing can cost investors around 1.5% a year in returns, he says.

The Smiths are in much better shape than they seem to realize, Roth adds, so there's no need to panic. Both Linda, a registered nurse, and Michael, who works for a pharmaceutical firm, will receive guaranteed pensions from their respective employers, which should provide the couple with roughly $4,200 in monthly income in retirement. The value of that pension, Roth says, is around $325,000.

Still, a few moves could help a lot.

Boost savings Right now Linda is contributing the maximum 15% to her employer-sponsored retirement plan. Michael says he can afford to put only 8% in his.

Roth disagrees, calculating that the couple - who earn a combined $198,000 a year - can easily boost their savings rate an additional 3% by cutting spending. Trimming their annual spending by $4,000 should improve their odds of success, Roth says.

Deal with their debt The only major red flag in the Smiths' balance sheet is a fair amount of debt. In addition to two car loans at more than 6%, totaling around $8,000, they have $26,000 in an education loan from when their daughter Rachel, 24, was in college.

And because they lent their son Jacob, 22, $120,000 to start a business, they owe $44,000 on their credit cards (their son has agreed to pay that down). "I told Jacob he has to stay healthy because he has a lot of my retirement money," says Michael.

Roth says the Smiths should get more aggressive in retiring these loans. For instance, the couple have $28,000 in cash savings now, currently earning 3.5%. He suggests using some of that money to knock down their debt, starting with the highest-rate loans. The sooner they get out of the red, the more quickly they can increase their retirement savings.

Commit to a strategy Michael and Linda need to settle on an asset-allocation strategy that's appropriate for them - and stick with it. Roth prefers a mix of 70% stocks and 30% bonds, which would provide decent growth while smoothing out many of the market's bumps.

After seeing the numbers, the Smiths tell Roth they're relieved. "This is much better than I expected," Michael says. "I was really depressed by losing so much money in the market. But I think maybe I'll get back in."

Be featured in Money Magazine: Do you (and your spouse) make more than $170,000 annually and worry about tax-efficient retirement planning? If so, send your name, age, occupation, income and questions, along with a recent photo, to makeover@moneymail.com. We will be providing advice to a family in this situation in an upcoming article - and it could be you!