Play catch-up with your retirement savings

Getting a late start on your 401(k) saving ? Here's what you can do to play catch-up.

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By Walter Updegrave, Money Magazine senior editor

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

NEW YORK (Money) -- Question: I'm in my 50s and I got a late start on my 401(k) plan at work. All my contributions go into a balanced fund, but when I get my statement each quarter, it seems that I'm losing as much as I'm contributing. Should I leave my money where it is or should I switch to another fund? --Linda Mandrell, Tampa, Florida

Answer: If it's any consolation, chances are that when you open your 401(k) statement at the end of this quarter, your balance may have stopped dropping - and might even have done an about face.

That's because since hitting lows in early March, the stock market has been on a roll, gaining more than 30% as of last week's close.

But whatever happens, you don't want to get too fixated on your 401(k) balance at any given moment. Granted, it's unsettling to see your 401(k)'s value sink. And to some extent your anxiety can be healthy. That uneasy feeling is probably a good indication of your true risk tolerance and can be helpful in guiding your investment strategy going forward. But you don't want to get so obsessed by setbacks in your account balance that you end up making a rash move that you may later regret.

I'm reluctant to use horseracing analogies when it comes to investing and retirement planning, but I think one applies here.

Remember back in early May when Mine That Bird won the Kentucky derby? Well, if you'd bet on that horse you'd have been pretty glum during most of the race. Mine That Bird was running dead last at the quarter-, half- and three-quarter mileposts. At one point, he was nearly 30 lengths behind the leaders before he began reeling in the field and eventually went on to win by nearly seven lengths.

I don't want to suggest that you should ignore a significant drop in your 401(k)'s value (or, worse yet, that you should be making long-shot investment bets in your 401(k)). Rather, my point is that what matters most isn't your 401(k)'s balance right now, but it's value in the future when you're ready to live off it in retirement.

Which brings us to the heart of the matter: What should you be doing to improve your chances of being able to retire in comfort?

Save, save, save

The single most important thing you can do is to continue funneling money into your 401(k). If you pare back your contributions or halt them completely because of your concerns about short-term declines in the value of your account, you will be undermining any chance you have of achieving a secure retirement.

Since you're getting a late start, you should try to ramp up your savings effort to the max. That means contributing not just as much as you can to your 401(k), but funding an IRA as well if possible (assuming you're eligible).

And don't forget about the catch-up provisions that allow people 50 and older to throw in an extra $5,500 into a 401(k) this year and an extra $1,000 into an IRA.

Choose an asset allocation

As for your investing strategy, you've got to balance two conflicting goals. On the one hand, you need to grow your retirement nest egg during the years you're still working. To do that, you'll have to continue investing a decent portion of your account in stocks. Yes, that might seem a scary or even foolish thing to do given this uncertain economy and volatile market. But, again, you're investing not for the next quarter or year, but for the next 10 years and beyond.

At the same time, though, you can't be so aggressive in your investing that you make yourself vulnerable to losses so large that they could jeopardize your long-term retirement security. After all, even though you do have time to bounce back from investment setbacks, you don't have as much time to rebound from them as people in their 20s, 30s and 40s.

At the moment, you say your entire 401(k) is in a balanced mutual fund. Although not all balanced funds maintain the same stocks-bonds mix, they typically invest 60% or so of their assets in equities and the rest in bonds.

You could argue that someone your age should hold a somewhat higher percentage of equities if, for example, that person has a higher risk tolerance or other resources to fall back on such as a company pension. And you could make a case for a lower percentage, if that person is more cautious and doesn't have much in the way of savings and other assets. But a 60-40 stocks-bonds blend is certainly reasonable.

That said, as you get older, you'll likely want to shift to a more conservative mix - i.e., a higher percentage of bonds. A balanced fund won't do that for you, however, since such funds generally keep their mix of stocks and bonds relatively stable.

So assuming you want to ratchet down your equity exposure as you get closer to retirement, you have a few options. One is to stay in the balanced fund and gradually shift more of your contributions into a bond fund so that bonds become a larger percentage of your portfolio over time. Frankly, though, I think this could be a messy and time-consuming process that might be difficult to manage.

Another alternative would be to create your own portfolio by mixing and matching different funds from your 401(k)'s investment lineup. To keep it simple, you could create your own mix by divvying up your money between a stock index fund that tracks the broad stock market and a bond index fund that mirrors the bond market, assuming such funds are available in your plan. I think this would be an easier strategy to follow than the previous one, but would still require a bit of effort on your part.

Your third option would be to go with a target-date retirement fund. You pick one with a date that's close to the year you figure you'll retire, say, 2020, and you get a ready-made portfolio of stocks and bonds that gradually shifts more of its assets into bonds as you age.

This would be the simplest and most convenient way to go. Even here, though, you'll want to check out how the target-date fund divvies up its assets prior to and during retirement, as some invest a significantly higher percentage of their assets in stocks than others.

To see what sorts of account balances different mixes of stocks and bonds might generate over different periods of time, check out the Morningstar Asset Allocator tool.

Remember, though, as important as it is to get your investing strategy right, it's even more crucial that you sock away as much as possible in your 401(k) and other retirement accounts. It would be unrealistic to expect that over the next 10 or so years you can make up for all the years of saving you missed. But if you combine an all-out savings effort with a sensible investing strategy focused on the long term, you still have plenty of time to build your 401(k)'s balance and dramatically improve your retirement prospects. To top of page

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