Simple steps to a fatter nest egg.
By Christine Benz | 04-19-05 | 06:00 AM | Email Article

Remember the late, great 1990s, when keeping watch over your 401(k) was actually fun?

Never mind that the market, and tech stocks in particular, were ridiculously overvalued. For a brief, shining moment, even lousy funds and poor 401(k) plans were posting mind-boggling gains guaranteed to bring a smile to your face.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

A three-year bear market that ended in early 2003 sobered most people up, though, and greed quickly turned to fear. These days, the dominant mood seems to be malaise. Investing is no longer the painful exercise it was in the depths of the bear market, but nor is it especially fun.

But it's possible to strike a balance between checking your 401(k) balance every morning and complete and utter portfolio neglect. For most investors, a once-annual 401(k) checkup is perfectly adequate.

The following steps should get you on your way.

1. Max out.
Most of us have heard over and over why we should be investing the maximum allowable amount in our 401(k)s.

But what you may not realize is that the maximum allowable amount is changing. After holding steady for much of the late 1990s, contribution limits have gotten more generous. In 2004, investors can contribute $14,000 to their 401(k) plans, and they can contribute $15,000 in 2006. 401(k) investors over age 50 can contribute $4,000 more in "catch-up" contributions in 2005, and $5,000 in 2006.

If contributing the allowable maximum is out of reach for you right now, make sure you're at least contributing the amount you need to take full advantage of any matching money your employer kicks in. Doing otherwise is like leaving free money on the table.

And if you haven't increased your contribution since you first began investing in your
401(k) plan, ask your human-resources administrator to show you what your take-home pay would look like if you contributed an extra 1% or 2% of your salary. You may find that because your contribution comes out of your check on a pretax basis, kicking in a little extra is a relatively painless way to save more.

If you've been lucky enough to get a raise over the past few years, consider steering at least a piece of that increase into your 401(k) plan. Behavioral economists Richard Thaler and Shlomo Benartzi have shown that savers who ratchet up their 401(k) contributions every time they get a raise do a much better job of replacing their income in retirement than those who do not.

2. Seek help.
Starting a new job is stressful enough, and unfortunately, that's precisely the time when most of us are called upon to put together our 401(k) portfolios. Is it any wonder so few people make well-researched choices?

In my experience, the key step many investors short shrift when building their 401(k) portfolios is creating a blueprint--an overarching view of how much they should have invested in stocks, bonds, and cash given the age at which they hope to retire, how much they're saving each year, and their risk tolerance. Instead of getting a big-picture view of how they should be investing, many investors proceed straight to picking individual funds. And even those 401(k) investors who did take care to determine an appropriate asset allocation initially may find that their portfolios have gotten off track due to the bear market or their own active maneuvering.

There are some basic rules of thumb for determining the appropriate stock/bond mix. A common one is to subtract your age from 100% to determine how much you should have invested in stocks and stock funds. That's better than nothing, but this is important stuff, and back-of-the-envelope calculations probably won't cut it.

For a more precise read on how you should be splitting your money, check out Morningstar's  Asset Allocator tool. (This tool is available to Morningstar.com Premium Members, but you can take a free trial run of Asset Allocator and all of the Premium features on Morningstar.com by clicking here.) To use Asset Allocator, you simply plug in your current portfolio value, your savings rate, your age, and when you hope to retire. Asset Allocator then helps you figure out how much you should have in stocks and bonds, and it also gives you guidance on how much you should have in stocks of various types, including small-company, large-company, and international equities. If it looks like you'll fall short of your goal, Asset Allocator lets you tweak each of these variables to help determine how to make it happen.

If you'd like even more guidance, check out Morningstar's  Retirement Planner tool. (Like Asset Allocator, Retirement Planner is part of Morningstar.com's Premium service, but you can take a trial run of Retirement Planner and all of the Premium features on Morningstar.com by clicking here.) Retirement Planner sizes up all of the funds currently in your 401(k) plan, then shows you an ideal allocation based on your goals, age, savings rate, and the funds' historical performance patterns.

3. Make sure you have a rock-solid core.
Because many 401(k) plans offer a long menu of choices, it's tempting to fill up on a little bit of this and a little bit of that. But the biggest favor you can do for your 401(k) plan is to stay away from the niche offerings and instead build out a solid core of rock-solid funds. Such holdings should make up 75% to 80% (or more) of your 401(k) portfolio.

For stock funds, your best core fund is typically a large-cap blend or large-cap value offering; conservatively positioned large-cap growth funds can also work well.  Vanguard 500 Index ,  American Funds Washington Mutual , and  Fidelity Contrafund  are all examples of fine core stock funds that frequently show up as options in
401(k) plans. Your best core bond fund, meanwhile, is a high-quality intermediate-term bond fund like  PIMCO Total Return  or a one-stop bond fund like  T. Rowe Price Spectrum Income . Morningstar's  Fund Analyst Picks list provides a healthy sampling of the core funds our analysts like the best, and Morningstar's individual Fund Analyst Reports give you complete, in-depth reviews of more than 2,000 funds.

Step 4: Avoid the big mistakes.
Last, but not least, vow that you'll do your part to avoid the big mistakes that can bedevil 401(k) investors. Remember the Enron lesson? That's right, don't load up on company stock. And take a loan from your 401(k) only as a last resort; such loans can carry onerous application fees, they reduce the money that's working for you in the market, and you'll have to pay your loan back with aftertax dollars. And finally, at the risk of stating the obvious, don't cash out of your plan prematurely. You'll face stiff penalties and tax consequences, and you'll also deplete money that you're almost certain to need later on.

A version of this article appeared Oct. 19, 2004.

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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