10 years to retirement - Are you ready?

(Money Magazine) -- Question: I have about 10 years until I retire, and I'm wondering whether I should put my 401(k) savings back into high-risk stock funds or a moderate-risk stock fund like a Standard & Poor's 500 index fund. What do you think? -- Paul, Brockton, Mass.

Answer: I know that risk is subjective. Some people can't wait to jump onto Kingda Ka, the roller coaster that soars 45 stories into the sky and reaches speeds of 128 miles per hour, while others, like me, think twice about a spin on the whirling teacup ride.

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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).

Ultimate Guide to Retirement

• Getting started
• 401(k)s & company plans
• Investing
• Annuities
• IRAs
• Self-employment plans
• Pensions and benefit plans
• Social Security
• Insurance
• Estate planning
• Living in retirement
• Getting help

But even allowing for such differences, I have to say that I don't consider either of the alternatives you mention as particularly reasonable choices for investing your 401(k).

You can argue about whether an S&P 500 index portfolio is moderate risk and what type of stock funds might be considered high-risk. It depends on the scale.

But that's not the most important issue here. What really matters is whether it's appropriate for someone your age to be putting all of his 401(k) assets into an S&P 500 portfolio, or any stock fund for that matter.

Let's consider the S&P 500 index for a moment. When you buy an index fund based on that benchmark, you get a portfolio of 500 actively traded large-company stocks. The fund is diversified in the sense that you've got lots of stocks that represent a broad swath of industries, 10 to be exact.

But just because the companies are big and diverse doesn't mean the ride can't get wild and crazy at times. From the stock market's high in October 2007 to its trough in March 2009, the S&P 500 index plummeted by 56%. That's a drop worthy of Kindga Ka.

That's not to say that you couldn't find any number of funds that did worse. A fund pegged to an index of foreign emerging markets stocks would have lost upwards of two-thirds of its value from peak to trough in the last meltdown.

Still, I doubt most people would consider putting their entire 401(k) into a fund that has the potential for that sort of decline as a moderate-risk strategy, especially if they're within 10 years of retirement. A setback of 50% or more is pretty tough to recover from late in one's career.

So to get back to your question, here's what I think: I think you need to re-think the way you think about risk. I know that's a lot of thinking, but, seriously, that's what you need to do.

Smart retirement investing isn't a matter of picking the right fund or choosing the right time to move from one fund to another. It's about building a portfolio, specifically a portfolio of both stock and bond funds that gives you a reasonable shot at getting you to and through retirement. That means a mix of funds that not only can deliver the growth necessary to build a nest egg large enough to sustain you through a retirement that could very well last 30 or more years, but also provide decent protection so that a meltdown like the last one doesn't totally derail your retirement plans.

You can get a quick idea of what blend of stock and bond funds might do that by checking out how a target-date fund for someone your age and proximity to retirement invests. Remember, though, that the amount a target-date fund invests in stocks can vary pretty dramatically from one fund company to the next, especially when it comes to target-date funds designed for older investors. I think the target-date funds offered by Vanguard and T. Rowe Price, both of which are on our MONEY 70 list of recommended funds, offer reasonable mixes.

The thing about target-date funds, however, is that their pre-set mix may not be quite right for you. Like Goldilocks with the three bears' porridge, you might find the funds too hot (too aggressive) or too cold (too conservative). To get closer to a mix that's just right, you can do a couple of things. At the very least, you can try plugging different stock-bond allocations into Morningstar's Asset Allocator tool. Among other things, you'll see the expected annual return for that mix as well as its possible short-term loss.

But if you really want to see whether you're on track for that retirement in the not-so-distant future, I think you ought to probe a little deeper. By that I mean going to a calculator like T. Rowe Price's Retirement Income Calculator or Fidelity's Retirement Income Planner, where you can enter not just info about your investments but about your planned spending in retirement. You'll then get feedback about the probability of your resources being able to fund the retirement lifestyle you envision. If the odds of success are uncomfortably low, you can re-run the analysis with some changes, including everything from saving more to investing differently to postponing retirement.

And, at the end of the day, that's really what you need to know. Not whether to put your money into a high-risk or moderate-risk stock fund, whatever that may mean. But how to make sure that you're making the right investments and taking all the other steps you should to increase your chances of achieving your goal of retiring in 10 years.