Is the 401(k) dead?

(Money Magazine) -- Question: I'm 23 and contribute to my 401(k) plan. My employer also invests 4% of my salary in matching funds. But after reading a 2009 TIME Magazine story titled "Why It's Time to Retire the 401(k)" and seeing my parents lose significant amounts of their retirement savings after 9/11 and again in 2008, I'm wondering whether I should stop contributing to my 401(k). I'm confused. What is the best way to save long-term for retirement? --Andrew H.

Answer: I can understand why you feel perplexed. On the one hand, people like me counsel workers to plow as much as they can into 401(k)s and similar retirement savings plans.

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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).

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At the same time, others out there (and the TIME story is hardly the only example) are saying that the 401(k) is a lousy idea whose time should never have come.

So how does someone like you who's trying his best to assure a comfortable retirement reconcile these two seemingly contradictory stances on the 401(k)?

Well, the best way to start is by realizing that these two views don't necessarily conflict.

How so? Well, the TIME article essentially looks at the 401(k) from a policy standpoint and tries to get at the issue of whether the 401(k) provides an adequate way to prepare for retirement. The article cites a number of well-known knocks against the 401(k) -- that many participants aren't particularly adept at investing their contributions, that account balances can get whacked hard during market setbacks and that turning one's 401(k) stash into a lifetime income is a major challenge -- and basically concludes that the 401(k) isn't up to snuff.

The article doesn't explicitly recommend an alternative. But in reading the piece I think you come away with the sense that we would all be better off if only more companies had stuck with the traditional check-a-month pension plans that have been disappearing in recent decades. I think the article also creates the impression that it would be a positive step if, the government would step in and guarantee a retirement paycheck in addition to Social Security.

The story also talks favorably about allowing workers to purchase guaranteed income throughout one's career from a retirement-insurance provider, although, oddly, there's no recognition that such a proposal isn't really at odds with a 401(k) system and, in fact, similar options are already being offered in some 401(k)s.

Reasonable people can disagree on whether the 401(k) should be replaced. Given the state of the Social Security and Medicare system, I'm reluctant to put even more of my retirement security in the feds' hands. As for going back to the days of yesteryear with traditional defined-benefit pensions, that's no more likely to happen than a return to black-and-white TVs with rabbit ears. (Besides, those pensions aren't exactly foolproof either, witness how many are underfunded.)

So with all due respect to my colleagues at TIME, I'll take the 401(k), with all its shortcomings, over any of the alternatives I've seen discussed so far.

But what I or anyone else thinks about the 401(k) as a policy matter isn't really the point when it comes to the practical issue of what you should be doing to save for retirement. The fact is that, for now at least, the 401(k) is the way your employer allows you to save for retirement. So the question is whether you should take advantage of it, or turn your back on it and save on your own outside of a 401(k).

I don't think there's any question that, barring some drawback like sky-high fees or horrible investment choices, it would be foolish to forego saving through your 401(k). You would be giving up convenience, the advantage of investing pre-tax dollars and, in your case, free money in the form of a match. So at the very least you should contribute enough to get every cent of that match.

Once you've done that, you might consider contributing to a Roth IRA, assuming you qualify. And if you still have money to save, you could then stash more in your 401(k).) But if you think there's the chance you won't follow through and contribute to the Roth IRA, then just stick to your 401(k).

Whatever you do, though, you certainly don't want to skip your 401(k) and invest in a plain old taxable account. That would make no sense at all.

Of course, you also want to do all you can to avoid the investing mistakes some people make in their 401(k)s. Diversify broadly rather than concentrating your money into one or two investments, and be especially wary about loading up on company stock, if it's on your plan's investment menu. Stick as much as possible to low-cost funds in your plan so that more of the gross return your investments earn goes into your account.

As for your concerns about losing money as your parents did, the solution isn't to avoid the possibility of losses altogether. Doing that would require investing in very low-risk assets, which means your savings wouldn't have much of a chance to grow, which in turn means you would have to save a lot more to build a nest egg large enough to support you in retirement.)

Rather, the idea to create a mix of assets that allows for sufficient long-term growth while also offering an appropriate level of protection, given your stomach for risk and how near you are to retirement. Generally, the younger you are, the more of your account you can afford to invest in stocks. The idea is you'll earn higher long-term returns, yet still have a chance to recover from the periodic setbacks that stocks suffer.

As you get older, though, you'll want to protect yourself more from stock downturns by shifting an increasing proportion of your assets into less volatile assets like bonds and cash. (Alas, research shows many people fail to do this.)

For guidelines as to what mix of stocks and bonds might be right for you at different ages, I suggest you check out the target-date funds offered by Vanguard and T. Rowe Price. If you're not comfortable putting together a 401(k) portfolio on your own, you might consider investing in a target-date fund, although there are also other options you might consider.

When you get closer to the end of your career, you can start thinking more seriously about how to turn your 401(k) balance and other retirement savings into a reliable stream of retirement income.

Ultimately, no one really knows the absolute best way of saving for retirement. But of the options that you actually have available to you today, I can't think of one that's hands-down better than a 401(k) -- and I can think of many that are a lot worse.