A recession won't wreck your retirement

New York (Money) -- Question: I've been contributing 15% of my salary and bonus to my 401(k), as well as investing in a Roth IRA and other accounts. With everyone so sure we're headed for a recession, I'm wondering whether I should move my money into more stable investments to avoid losses as some people suggest or whether I should just view this time as an opportunity to buy in at cheaper prices. What do you think? --Sandy R., Los Angeles, Calif.

Answer: The only sound that's louder and more persistent than the parade of recession warnings out there is the clamor of pundits spouting strategies that will supposedly safeguard your retirement in the face of a downturn.

Some advocate waiting out the turbulence in cash equivalents like money funds or CDs. Others suggest investing in foreign markets, and still others recommend moving into market sectors that have historically held up well in recessions past.

I call this paper-mache advice. It looks solid at first glance, but doesn't hold up to closer examination. The main problem is that these recommendations assume you can move your retirement money in and out of different assets with impeccable timing. In reality, you run the risk of selling at a low point and buying in at inflated prices. Throw in the cost of trading, and you can seriously erode your long-term returns.

So what can you do to prevent your nest egg from getting totally scrambled?

Below, I offer strategies for four different stages of retirement planning - early career, mid-career, late career and already retired - that will get you through a recession and a down market while still allowing you to prosper in the longer-term.

But first I want to mention one thing that almost everyone should be doing in an iffy economic climate like this. While it's always a good idea to have a cash reserve of three to six months' living expenses to fall back on, it's particularly crucial to have such a cushion now. Recessions dramatically heighten the risk of job loss. During the last recession of March to November 2001, for example, the United States lost 1.6 million jobs. Having an emergency reserve will reduce the chance that you'll have to raid your IRA or other accounts and disrupt your nest egg's growth if you're laid off.

As an added precaution, you should also have a home equity or other line of credit to give you another resource to draw on if things get really ugly and your cash reserve runs dry. If you don't already have a line of credit, open one now, as you may not be able to get it if you become unemployed.

Now let's get to those strategies for different stages of retirement.

Frankly, your main focus at this point in your planning should be making sure you're plowing enough money into your 401(k) and other retirement accounts, not following the ups and downs of the economy and the markets. You can quickly tell whether you're stashing away enough by going to our What You Need To Save calculator. Just plug in your age, annual salary and the amount you already have saved, and bingo! You'll get an estimate of the percentage of salary you need to put away to retire at age 65.

As for your investing strategy, your goal is to shoot almost exclusively for long-term capital growth. With retirement still 30 or 40 years away, you have plenty of time to recover from temporary losses, so there's little sense in getting all worked up about them. Indeed, anyone who invested in a diversified portfolio of stocks at the market peak in January 1973 right before a bear market drove stock prices down nearly 50%, still earned an annualized 10.6% over the next 30 years.

I'm not saying you'll see a repeat of those results. But stocks still offer your surest shot at long-term growth. So when you're in your 20s and 30s, the best strategy is to devote about 90% of your retirement assets to solid low-cost mutual funds like the ones in our Money 70 and, except to rebalance your portfolio annually, stick to that strategy whatever the market is doing. If you're not up to creating your own portfolio, buy a target-date retirement fund with a date that roughly corresponds to the year you plan to retire, say, 2040 or 2050.

After you've got a few years on the job, you probably have enough money sitting in 401(k)s and IRAs that a market downturn would trigger a big enough dollar loss to get your attention. Which means you could be even more prone to abandon your long-term strategy to avoid short-term pain.

Resist that urge. With 20 or more years to go until retirement, you still have lots of time to make up for any setbacks. So long-term growth of your savings is still your overriding investment goal, although with fewer years left in your career you'll want to be slightly less aggressive than you were starting out. A mix of roughly 70% to 75% of your retirement savings in stocks and 25% to 30% bonds is generally appropriate if you're in your 40s and early 50s.

You'll also want to be sure you're continuing to sock away enough bucks in your retirement accounts. While our What You Need To Save calculator can give you a quick sense of whether you're on track, at this point you probably have enough money in enough different accounts that you're better off doing a more comprehensive analysis with our Retirement Planner. By running a couple of different scenarios using different assumptions about your savings rate and investment strategy, you can get a much better handle on whether you're on track and, if not, what you must do to make progress.

Now you're hitting the home stretch with about 10 years to go until retirement. Now that the kids are leaving the nest and you're at or near your peak earning years, this is an excellent time to really rev up your savings effort - including making catch-up contributions to your 401(k) and IRA once you hit 50.

On the investment front, however, you face a delicate balancing act. You still need capital growth because you're investing not just until you reach retirement, but for the years you'll spend in retirement too. But you also need to protect the money you've accumulated so far.

The way to balance those needs isn't to try to time moves in and out of cash, bonds or defensive sectors. Rather, it's to settle on a mix of stocks and bonds that can give you a decent shot at long-term growth while providing enough shelter so that you're not hammered when the market goes south. Generally, that means keeping roughly 60% to 65% of your portfolio in stocks and the rest in bonds.

You also need to begin thinking not just about growing and protecting your nest egg, but gauging how much retirement income it can realistically generate. By plugging in such information as your account balances, how much you're saving, your estimated Social Security benefits and your investment mix, an online tool such as Fidelity's Retirement Income Planner can help you estimate how much income you can reasonably count on in retirement. (The tool is free, although non-Fido customers must register.)

This is the time when you really have to be careful about market slumps. That's because the combination of investment losses and pulling money out of your retirement accounts for living expenses can so depress the value of your portfolio that it may not be able to recover sufficiently even when the market rebounds.

There are two ways to protect yourself against the risk of going through your money too soon. One is to scale back your stock holdings enough to allow for modest growth yet limit the damage from a slumping market. At age 65, a reasonable guide is to invest roughly half of your retirement accounts in stock funds and the remainder in bonds and cash. As you age, you should gradually scale back the amount devoted to equities, until it reaches 20% to 30% of your portfolio when you're in your '80s.

The second way to prevent a sinking market from sinking your retirement plans is to carefully manage withdrawals from your savings. If you want your nest egg to support you for 30 years to longer, you should draw no more than 4% to 4.5% or so of your account value initially and then increase the dollar amount of that withdrawal annually for inflation. This will give you an 85% to 90% chance that your money will last 30 or more years.

This is an estimate, though, not a guarantee. The odds will be lower if you're hit with several years of subpar returns or a market downturn early in retirement. If the markets deliver solid gains, however, you could actually end up with a portfolio larger after 30 years than the one you started out with. That may sound like a big plus. But it could also mean that your desire for security prevented you from enjoying retirement as much as you might have.

So you need to be flexible. If the markets head south early in retirement, you might want to pare back your withdrawals a bit. Conversely, if you see your portfolio's value begin to balloon, you might be more generous to yourself. You can keep tabs on how long your portfolio might last by going to the T. Rowe Price Retirement Income Calculator.

Bottom line: The threat of a recession and a bear market wreaking havoc with your retirement plans can definitely be unnerving. But shifting assets around in a vain attempt to outguess the markets will likely create more problems that it will solve. A better approach is to create a sensible long-term plan along the lines I've outlined here and, aside from minor adjustments, stick to it. In the years after the crisis passes, you'll be glad you did.