Four Ways to Optimize Your 401(k)
by Mike Woelflein
Tuesday, February 12, 2008
provided by TheStreet.com


The stock market's wild gyrations make this a good time to check on your 401(k).

No panic moves, mind you.

Instead, put your portfolio through its paces to make sure it's doing what it needs to do to help you reach retirement in good financial shape.

Here are four pieces of advice worth taking:

1. Consider Being More Aggressive

Recent events notwithstanding, stocks perform better than other investment vehicles over time. The typical stock fund averaged a 10.4% annual return from 1926 to 2005, compared with 3% for inflation, less than 6% for bond funds and less than 4% for Treasuries. And while stocks can be volatile, the risk of holding them diminishes over time.

Stocks have outpaced both bonds and Treasury bills during more than 75% of rolling five-year periods since 1926, according to Ibbotson Associates, a Chicago-based investment research firm owned by Morningstar. Look at 10-year periods, and stocks won 85% of the time. For 15-year periods, the percentage jumps to 92%. Your allocation to stocks should match your time horizon and risk tolerance.

Remember: your target date should not be the year you retire. Your retirement may well last for decades, and during that time your portfolio will need to grow enough to stand up to inflation, including rising health-care costs. Bottom line: Even as you approach and pass the end of your working years, don't be afraid to emphasize growth -- meaning stocks.

2. Expand Your Horizons

Today's 401(k) plans tend to offer a broad array of investment possibilities. Consider whether your portfolio is taking advantage of them. Investment vehicles such as emerging-market stocks, high-yield "junk" bonds and small company stocks offer superior growth over the long run. They may seem risky -- and in isolation they are. But when you hold them with other investments, they can actually reduce your overall risk. That's because these asset classes tend to zig when other segments of the financial markets zag. As a result, they can help smooth out the year-to-year returns of your portfolio even as they increase your potential for long-term gains.

3. Identify Losers and Overlapping Funds

Review each fund in your portfolio, and compare it to others in the same category both inside and outside your plan. For example, how does your small-cap growth fund compare with other funds that hold shares of small growth companies? (You can find this info at websites such as Lipper.com, Morningstar.com and fund-company or 401(k) plan sites.)

Compare both returns and volatility over one, three and five years, with an emphasis on the longer term. While you're at it, look for fund overlap, which occurs when two funds are concentrated on the same stock or sector. For example, if you hold several funds that have invested heavily in technology stocks or long-term bonds, you could be overexposed to a decline in those sectors.

4. Coordinate Your 401(k) With Other Accounts

Let's say that your plan's options in some categories aren't appealing. In that case, consider investing in the plan's strongest funds, then diversifying into other categories through an IRA or taxable accounts.

The bottom line: As a retirement account, your 401(k) should focus on the long term. But tweaking your holdings can improve that long-term outlook -- and might also offer some shelter from the market gyrations that will occur in the meantime.

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