4 smart fixes for your 401(k)

(Money Magazine) -- With stocks up more than 60% since hitting bottom last March, the red ink is finally fading on the typical 401(k) account. Yes, it's safe to look at your statement again: Balances for boomers who have worked 10 to 20 years at the same company are now down less than 3% on average, compared with pre-crash levels; younger employees and 45- to 64-year-olds with less tenure are solidly back in the black.

That's a stunning turnaround from the 25% or more losses of just a year ago. So what if some of that lost ground was made up with new contributions and employer matches? Getting back to even, or pretty darn close, still feels like a major victory.

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Don't bask in self-congratulations too long, though. Fact is, you have to do a whole lot better than merely recovering your losses to get your 401(k) on a winning track.

"Many people were two or more years behind on their savings even before the crash," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "The market rebound has put their balances back closer to where they were, but not to where they need to be."

Getting to that goal may seem daunting, but recent developments in the 401(k) world should make the challenge easier to meet. Many plans have improved their investment options, allowing you to better protect your portfolio against market mayhem. They've also added tools that make it easier to rein in costs and adjust your asset mix as financial conditions change.

Just as important, the lessons learned from the experience of the past 18 months -- especially the way most investors handled the downturn -- suggest new strategies going forward that can help you manage your 401(k) more profitably. To move beyond square one, follow these four steps.

Don't just stand there

The typical 401(k) investor did not react to the financial crisis by selling in panic, as many advisers feared. Instead, most plan participants (80%) did ... nothing. And inertia is the most dangerous path of all for many retirement savers. Not making any portfolio changes as shares peaked in 2007 was a big reason many preretirees had hefty stock stakes when the market crashed in 2008 -- nearly four in 10 employees ages 56 to 65 had more than 80% of their 401(k)s in stock, according to the Employee Benefits Research Institute. And it's likely they had losses of 30% to 40% as a result.

Don't repeat that mistake. After the 2009 surge in stock prices, your asset allocation is probably out of whack again. The solution: Rebalance your 401(k) now, shifting money out of stocks and into fixed-income investments until you're back at your target weightings.

You'll also need to rejigger your holdings of subcategories of stocks, lightening up on small, midcap, and foreign stocks, which have gained the most, and betting more on blue chips.

Some good news: The process is easier now that nearly half of 401(k)s offer an automatic rebalancing option, up from 11% six years ago; many other plans provide an online tool to help you do it yourself.

As you fine-tune your mix, take advantage of opportunities to diversify into asset classes that can help improve your returns and reduce risk. In the past two years many plans have added investments to their menu: 12% now have an inflation-protected bond fund, and 19% offer real estate funds, according to Hewitt Associates.

Pump up to double digits

No matter how well you position your portfolio, you can't count on market gains alone to power your 401(k) to greater heights. The only sure way to keep your account balance growing is to contribute more to your plan. Yet only 23% of participants have boosted the amount they're saving in the past year, and 20% are contributing less, according to a survey by Wells Fargo.

That won't cut it -- especially if you're among the vast majority of 401(k) investors who don't kick in much more than is needed to qualify for the maximum employer match (typically 50% of what you put in, up to 6% of your salary). Aim instead to contribute 10% to 15% of your pay (your limit: $16,500 in 2010, plus another $5,500 if you're 50 or older).

The higher bar is more reachable than you might think because the tax break you get on your contributions reduces your net outlay; investing an extra $6,000 a year, or $500 a month, costs you only $360 out of pocket if you're in the 28% bracket. A few judicious nips and tucks to your budget should yield most of what you need.

Zero in on low-cost options

A long-term investor in a 401(k) plan that charges 1.5% in annual expenses is likely to end up with a 20% smaller nest egg than someone in a plan that costs 0.5%, according to a GAO report. Does your 401(k) charge that much or more? Unfortunately, it's tough for you to know now, since total costs, which include fund expense ratios and administrative charges, are often poorly disclosed.

Legislation has been introduced in Congress to address the problem, and the Labor Department is expected to release new rules in early 2010 requiring greater transparency about fees.

But don't wait for the feds to act. Check out how your plan stacks up against others in its industry at BrightScope.com, a new, free 401(k) service that evaluates more than 15,000 plans on factors such as fees, investment choices, and company matches. If your plan's fees are high, be especially vigilant about favoring low-cost options, like index funds (typical expense ratio: 0.2%) and institutional funds (0.8% or less), vs. actively managed retailstock funds (1.4%).

Stuck in a plan with high fees and no solid low-cost fund choices? Invest just enough to get the full employer match, then kick in the max on a traditional or Roth IRA at an online brokerage or fund company, where you'll have access to low-cost mutual and exchange-traded funds. (If you can afford to save more, follow the same strategy in a taxable account.) Over the long run, the extra money you make by lowering expenses will more than outweigh the forgone tax breaks on your 401(k).

Build your safety cushion

Call it the danger zone: The five years before you quit the workforce is when your 401(k) is most vulnerable to a plunging market. If you don't have time to repair the cracks in your nest egg before you exit, and you're forced to draw on a shrunken account for retirement income, you greatly increase the odds you'll eventually run out of money.

Embrace your inner conservative during this period. "Most investors should keep no more than 40% to 50% of their portfolios in stocks at retirement," warns Denver financial adviser Charles Farrell, author of Your Money Ratios. If you're investing in a target-date fund, which automatically shifts to safer assets as you age, make sure the manager is really doing the job (find its recent allocation at morningstar.com). During the crash, 2010-target-date funds lost 25% on average because many had loaded up on emergingmarket stocks, subprime mortgage bonds, and other risky assets.

Building cash reserves outside your 401(k) equal to two to three years of expenses will also help you to ride out a downturn without tapping a depleted nest egg.

Another option: At retirement, invest some of your savings in an immediate annuity, which will give you a regular monthly paycheck. Compare offerings at immediateannuities.com, and stick with a financially strong insurer, rated A or better from A.M. Best or Standard & Poor's. Treasury officials are now pushing for an automatic annuity option in 401(k) plans. But until that happens, you'll have to provide your own life vest.