YOUR MONEY: Reworking portfolio can provide protection

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...

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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