401(k) Sticker Shock Can Be a Wake-Up Call

For workers in 401(k) retirement savings plans, the sticker shock may be severe as midyear reports arrive in the mail.

June statements probably will show that the typical 401(k) investor has lost substantial ground this year--courtesy of the stock market’s harrowing decline. And those statements won’t include the damage from the market’s continuing plunge this month.

The heavier the investment in stocks, of course, the greater the losses are likely to be. A Hewitt Associates survey of 401(k) plans covering 1.5 million workers showed that about 58% of plan assets were in stocks in June.

That is down from about 67% in June 2000, principally because the market has declined so sharply rather than because investors have stopped buying stocks through their 401(k) plans.

Indeed, many investors have continued with the same asset allocation plan all through the now 2-year-old bear market. But as stocks’ losses deepen, the question of whether it’s time to make significant changes in 401(k) assets is looming larger for more Americans.

Should you change your investment mix? Should you cut back on stocks in favor of safer assets? Or should you just stand pat?

There’s no single answer that applies to every person. But here’s an action plan that can help 401(k) investors who are debating whether they should make some changes:

* First, get your bearings. Knowing how much money to allocate to various investment options is as much art as science, said Marc Pressman, owner of Pressman Financial Consulting in Oak Park, Ill.

But it helps to create an “investment policy statement” specifying your goals and the amount of risk you’re willing and able to take.

Those with predominantly long-term goals--retirement 10 or more years away, for example--should still feel comfortable allocating a larger percentage of their assets to stocks, both domestic and international, than those who are within a few years of needing to spend retirement money, experts say.

Near-retirees will want at least five years of spending power sheltered in plan options that promise a stable principal value, many financial advisors recommend.

As part of your 401(k) review, make sure you know all of the investment options available in your plan. New options may have been added by your company since you last changed your allocations.

* Focus on basic diversification. Despite the Enron Corp. debacle and other huge corporate bankruptcy filings this year, Hewitt’s recent survey found that many workers continue to allocate large percentages of their 401(k) savings to their own company’s stock.

Roughly one in three investors have 75% of their retirement assets in company stock, while 15% have all of their retirement savings in their own company’s stock, the survey found. On average, nearly 28% of plan assets are in company shares.

Yet, “The rough rule of thumb is that you shouldn’t have more than 5% to 10% of your assets in your own company’s stock,” Pressman said.

It isn’t just that investing in one stock is exponentially more risky than investing in a broad basket of shares. Workers also must remember that if their savings are concentrated in their employer’s stock, they risk having both their job and their savings in jeopardy at the same time. As former Enron, WorldCom Inc. and Global Crossing Ltd. employees can attest, that can be a terrible combination.

Of course, some investors have heavy company stock allocations because their employer matches their contributions solely in company stock. But to the extent an investor can reduce the total allocation to company shares, it’s wise to do so, experts say.

Basic diversification also means owning both domestic and foreign stocks, and smaller stocks as well as blue-chip issues. It also demands owning some fixed-income securities, such as bonds or so-called stable-value funds offered in many 401(k) plans.

In the long run, returns on fixed-income options should be lower than returns on stocks, because the risk typically is lower with the former. That’s why investors should be wary of rushing into income options now, even though their returns on midyear statements will look attractive relative to stocks’ losses, advisors say.

The reason to always own some income securities is that they can partially offset stocks’ losses in down markets, giving more stability to your overall portfolio, said Judy Lau, a certified financial planner in Wilmington, Del.

That’s a lesson many investors may feel that they’re learning too late. But it’s never too late to provide a portfolio with essential diversification, advisors say.

For help determining what your best asset mix might be, try mutual fund company Vanguard Group’s Web site, at www .vanguard.com.

* Remember that you have two ways to change your mix. You can dramatically alter how your assets are allocated by shifting money among investment options--for example, by telling your plan administrator to sell 20% of your stocks and use that money to buy into a fixed-income option.

You also can make more gradual changes by altering how your new contributions, and those of your employer, are allocated.

Many advisors favor the gradual approach because they note that the other option is a form of market timing, which is a game few have ever been known to win.

By simply shifting new (401)k contributions into safer assets, investors who now are fearful about stocks can sleep better at night knowing that they have taken steps to safeguard more of their portfolio in the long run.

They also won’t have to live with the fear that they might be taking a big chunk of money out of stocks right before the market recovers.

* Realize that you may want to invest more in stocks now rather than less. Once a year, investors should look at their 401(k) balances and make sure that the percentages allocated to each asset class still match their goals. This is called “rebalancing.”

Normal market gyrations often throw a portfolio off balance, Pressman said. Given the stock market’s two-year dive--the blue-chip Standard & Poor’s 500 has fallen 26% this year alone--some investors may find that they now have far less in stocks than they planned, as a percentage of total assets, said Lori Lucas, a benefits consultant with Hewitt in Lincolnshire, Ill.

As painful as it might be to throw good money after bad, experts maintain that it’s usually wise to shift money out of asset classes that have performed well recently into the areas that have performed poorly. This is especially true for investors who have a long time before retirement--say, 15 or 20 years.

“Investing is counterintuitive,” said Mark Brown, partner at Denver planning and investment firm of Brown & Tedstrom. “When things are going lower, you are wringing risk out of the market, which makes it a good time to buy. It is the essence of buying low and selling high.”

* Boost your contributions to your plan. The average employee contributes 7.5% of pay to a 401(k). The law allows workers to contribute substantially more--usually about 15% of wages.

The result of low contribution rates is that the median 401(k) balance is less than half of one year’s pay--clearly far too little to supplement a comfortable retirement. What’s more, some 30% of active plan participants have saved less than $5,000 total, according to the Hewitt study.

Last year’s tax law boosted the maximum amount individuals can contribute to a 401(k) to $11,000 this year, from $10,500. In coming years, the maximum contribution amounts will rise further.

Why boost contributions? Even if stock market returns are subpar for years to come, any returns are growing tax-deferred in a 401(k), and that’s a big advantage.

If your employer matches any percentage of your contribution, the more you pay in, the more your employer does as well. That’s “free” money--or lost money, if you don’t take advantage of it.