Don't Let Your 401(K) Slip Away

Last night, 60 Minutes did a saddening piece on the massive losses many Americans have sustained in their 401(K)'s. It profiled several individuals, near their retirement age, who are now facing a lifetime of work due to the precipitous decline in their 401(K)'s. It is a story that is too common today. Unfortunately, this is an event that could have been avoided, especially for the people near retirement age. Here are some tips on managing your 401(K):

1. Always Remember That Reward=Risk

When you open a 401(K) account, the list of choices is daunting. It is filled with financial terms that are difficult to understand. The fund names are grand and exciting. So how do most people end up selecting the funds? Their optimism gets the best of them, and the select the funds with the highest return, which is the one financial metric on the sheet that is easy to understand.

This is where most people go wrong. Risk and reward is a fundamental tenant of finance. In order to attract capital to riskier investments, larger returns must be offered. If you see a fund in your 401(K) that has a 18% return, that means that the fund manager is taking significantly more risk with your money than one with a 3% return invested in government bonds. Those funds have a higher upside, but the downside can be rough, as you have seen lately.

This does not mean that you should avoid the higher return / higher risk funds. It simply means you should not bet your retirement on them.

2. Remember That A 401(K) Balance Is NOT How Much Money You Have

This is a common misconception, and can lead to big miscalculations when planning your financial future. When you log on and check your 401(K) balance, you are not seeing how much money you "have" in your account. Your are simply seeing what the market will pay today for the assets you have listed in your account. Markets can fluctuate on both economic conditions and speculative fervor.

When planning you future, you need to understand what assets that you have in the account, not just the balance. A person with a 401(K) in cash or government bonds can rely on that money as being their when they need it. If your money is in stocks, you simply have a claim on the future income of that company or industry segment. Your 401(K) balance is the going rate for that claim today.

What does that mean in the real world? It means that when you look at your 401(K), think about as a claim, not a balance. Think about the company or segments that your money is in, and their potential value in the future. Focus on where you money is, not just how much.

3. Worry About Where You Are, Not Where The Markets Are

401(K) planning is about individual circumstances. As evidenced by all the traders looking for jobs, not even financial professionals can time the markets. Don't try. You asset allocation should be determined by your needs. If you are nearing retirement age, you should be heavily invested in low-risk bonds and treasuries. The people in the 60 Minutes piece could have avoided major losses, has the managed their 401(K) appropriate to their circumstances. Everyone is scared to miss out on the markets next big move upwards. The problem is, those folks usually get caught up in the crash.

4. Take Advantage of Retirement Targeted Funds

Most people don't have the time to get learn the difference between growth and income funds. The term "asset allocation" eludes many who make a living from something other than finance. If you are unsure about selecting your 401(K) funds, ask for help! Check with your employer. Many companies offer free financial planning seminars.

Retirement Targeted Funds are growing in popularity. They ease the burden on deciding where to put your 401(K) money. All you have to do is select the year that you plan to retire, and the fund will do the rest. It will shift your money from stocks to bonds and cash as you grow older. It takes the worry out of the equation. You should still monitor these funds, but they make sure you will not reach 60 and suddenly see your retirement evaporate.