If you own a 401(k), you may have asked yourself questions like these over the past two years:
"How can I stop the bleeding?"
"Should I put all my money in bonds?"
"Do I know what I'm doing?"
You didn't ask such questions in 1999. No matter how you allocated your money in a 401(k) back then, the raging bull market almost always delivered robust returns. Investment mistakes were lost in the stampede. Many investors put their plans on cruise control and went to sleep.
Now the bear market that began growling in 2000-and intensified after the terrorist attacks last fall-has jolted these once-nonchalant investors into high anxiety Now they dread opening their 401(k) quarterly statements and discovering that their accounts have shrunk again.
You can say one good thing about a bear market, though-it often wakes people up to basic investing principles. And the basics very much affect 401(k)s. You set goals, decide on your tolerance for risk, build and maintain a diversified portfolio, and hang on for a long ride. With patience and discipline, you'll amass a nice pile of money.
But 401(k)s-and look-alike 403(b) plans offered by nonprofit institutions-require additional finessing because of the laws that govern them. With just a little homework, you can manage your 401(k) through good markets and bad to a comfortable retirement. Here's how.
Contribute the max-- and the max has gone up
There are three good reasons for pouring as many dollars as you can into a 401(k).
One, it's better to save too much than too little for retirement, and doctors have been tempted recently to slack off.*
Two, you want to minimize what you owe Uncle Sam. Income tax on your pre-tax 401(k) contributions and earnings is deferred until you start withdrawing the money when you've retired and you're presumably in a lower tax bracket.
And three, if your employer matches your contribution, why pass up free money? Ante up at least enough to get the maximum your employer will contribute. The most common match is 50 cents on the dollar up to 6 percent of income.
Regardless of the employer's maximum, federal law limits your pre-tax contribution to $11,000. Thanks to President Bush's 2001 tax overhaul, though, this amount will rise $1,000 a year between 2003 and 2006, to $15,000. Beyond 2006, increases will be keyed to inflation in $500 increments.
Bush's tax package also includes a "catch-up" provision that allows people 50 and older to kick in an extra $1,000 in 2002. This amount will stairstep $1,000 each year until it plateaus at $5,000 in 2006. A 50-year-old could contribute a total of $20,000 that year.
Choose the right funds for your investing goals
To build a solid 401(k) portfolio from a menu of fund choices, you've got to understand the fundamentals of investing. You can explore this subject more deeply at the Medical Economics Web site (www.memag.com), where you can read "What it takes to be a successful investor" under "Your Money 101" in the Library section. Or, immerse yourself in respected financial Web sites such as www.morningstar.com, or sites that specialize in 401(k)s, like www.401khelpcenter.com.
No matter where you get your education, you'll learn that anyone who's more than 15 years away from retirement should funnel most of his money into a spectrum of stock mutual funds: domestic and international, growth-oriented and income-oriented, large company (called a large cap, as in capitalization), medium company, and small company. Your financial education will include how to allocate your funds among the various types of investments you select (what percentage of your money to keep in each type).
Most 401(k) providers try to dumb down portfolio building. They assume participants are investment rookies and steer them to safe bets. A plan will usually include at least one middle-of-the-road choice, such as an index fund or a growth-and-income fund. …