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Question:
I'm worried about losing money in my 401(k) because my
mutual fund choices seem risky. I have about 70 percent
in a variety of stock funds and the rest in bond funds.
I think the stocks in the stock funds are overvalued.
And I think the bond funds are at risk because interest
rates are expected to go up. I know that if rates rise,
bond funds will lose money. So what do I do? Though I'm
57 and plan to work 10 more years, I could lose my job
soon and might not be able to get another. There are
layoffs at my office.
Answer:
You are asking important questions, considering the
times: With layoffs, some baby boomers are ending up in
retirement long before they choose it. So you are wise
to be thinking about when you will need to start using
that money. Typically, financial planners suggest that
57-year-olds, with about 10 years to go before
retirement, invest about 60 percent of their 401(k) in
stock funds. That should give stocks time to recover
from a downturn by the time the money is needed.
But if
you seriously think you will lose your job, not be able
to find another and have to live on your savings
immediately, "consider investing like you are in
retirement," said
Charles Farrell
, a
Denver
financial planner and author of "Your Money Ratios:
8 Essential Tools for Financial Success and
Security."
Farrell
suggests retirees invest only about 40 percent of their
retirement savings in stocks because they would lose
about 20 percent in a 50 percent market decline —
similar to the recent downturn — rather than the 30
percent possible with 60 percent in stocks.
Paying
attention to bonds is also important, because they are
supposed to be your buffer from stock downturns and the
money you can spend waiting for stocks to heal.
This is
tricky, though, in a 401(k). Generally, 401(k) plans
merely offer bond funds. Those funds are fine for young
investors who invest money constantly through the ups
and downs in interest rates. But bond funds are not
ideal for retirees who could be facing a loss when they
need to start withdrawing money.
Bond
funds are not as safe as individual bonds such as U.S.
Treasurys. When people buy individual government bonds
and hold them until they mature, they can count on those
bonds. They won't lose money. But when interest rates
rise, bond funds lose value. Last year the average
Treasury bond fund lost 6.48 percent, according to
Lipper.
To
understand why, simply consider 10-year Treasury bonds
that are paying about 3.8 percent interest. If interest
rates rise in a few months and people can find Treasury
bonds paying 5 percent, they won't want today's rate. So
those bonds will lose value, along with funds containing
them.
Even the
pros are bad at predicting interest rates. But if you
are worried about rising rates and a loss in bond funds,
you have options.
You can
buy government bonds individually. You can count on the
interest they will pay you, and you will get back your
principal — the money you invested — at a promised
date. However, most 401(k) plans don't let you do this.
See whether your employer offers a
"self-directed" option that lets you buy
individual stocks and bonds from a broker for your
401(k).
If you
can't, open an IRA at a discount broker and buy
individual bonds in it. Invest enough money this year in
your 401(k) to receive any matching money from your
employer; then take additional savings and deposit them
in the outside IRA for bond investments.
Given
your desire for safety, buy Treasury bonds or perhaps
general obligation municipal bonds issued by states.
Farrell
suggests that individuals put only 2 percent to 3
percent of their bond money into a single bond. That
allows you to buy several bonds over the years, with
each maturing at different times. For example, now you
might buy what's called a strip, a U.S. government bond
that would mature in 15 years and pay you about 5
percent. Then, if interest rates rise in a few months,
you will have money for a bond that will pay higher
interest.
If you
stick with the bond funds in your 401(k), Farrell
suggests putting some money into a short-term bond fund
and some in an intermediate bond fund. But skip
high-yield funds.
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