How to Monitor Your 401(k)

When you started investing through your 401(k) plan, you had reasons for the mix you chose. Maybe you owned a few large-company stocks outside the plan, and you wanted to use your plan's small-cap and foreign options to fill out your portfolio. Or perhaps as a growth investor at heart, your non-401(k) investments leaned toward the technology and telecommunication sectors. So you devoted your 401(k) investments to value and fixed-income funds for balance.

Keep those reasons in mind as you monitor your 401(k) holdings. You don't want your funds to start doing things differently or change their styles, because that could undermine their roles in your portfolio. For example, CGM Capital Development started out in 1992 with a focus on small companies, but now it favors large-company stocks. So it wouldn't round out a portfolio full of large caps.

Use Morningstar.com's Portfolio Manager to watch out for changes. Enter all your stocks and funds into a portfolio, or create a separate portfolio to track only your 401(k) holdings. Morningstar.com premium members can view the stock styles of all their holdings with the X-Ray feature. Return to that page every six months or so, and make sure the styles continue to apply.

You should keep a close eye on funds that have changed styles in the past, because they may do so again. Premium members can see what styles their funds employed over the past three years on Morningstar.com's Quicktake page. Click on Investment Style on the menu on the left side of the screen. You'll see the fund's current style and its investment-style history there.

If you're a premium member, we'll even do this work for you. After you have created a portfolio, sign up for e-mail alerts by clicking on the Get Updates & Alerts tab. Check the box for portfolio and click on Daily Portfolio Alerts, and we'll notify you when there's a shift in your holdings' Morningstar style-box position or category.

2. Be Fair
You wouldn't expect the weekend golfer at your local course to compete with Tiger Woods, would you? You shouldn't judge diverse investments by the same standards, either.

In "Setting Realistic Expectations", we encouraged you to use relevant benchmarks when assessing performance. Don't hold everything to the standard of the S&P 500 index, for example. That's only appropriate for large-cap U.S. stocks and funds, not for small or foreign companies and certainly not for fixed-income funds.

For mutual funds within your 401(k), the best gauges are their Morningstar category rankings. Those tell you how funds stack up with others that employ similar investment styles.

When you review your 401(k) funds, look at their calendar-year category rankings. You can get those by clicking Calendar-Year Returns in the Quicktake menu. Your funds might not always post chart-topping numbers, but they should be above average (that is, better than half its peers) consistently. Still, one or two years of subpar performance shouldn't be a red flag.

3. Stay Abreast of the Terrain
Occasionally, the human-resources department or a committee within your company may alter the makeup of your 401(k) plan. You should stay informed about this process and get involved if you can.

If your plan's sponsor adds or deletes options, you could be forced to make changes to both your 401(k) plan and taxable accounts.

That's what happened when Morningstar reworked its 401(k) plan near the end of 1999. (See "Beyond the Textbook, Out of the Laboratory".) The changes were generally well received, but some of us were disappointed that the committee dropped T. Rowe Price New Era and didn't replace it with another hedge against inflation. The fraidy-cats among us who want a safety net in the event of inflation now have to decide how to compensate for that risk outside the plan.

4. Resist the Urge to Tinker
It's easy to manipulate the holdings in your 401(k) plan. The account is shielded from taxes, so Uncle Sam won't penalize you when you move money around.

Don't do that too much, though. Reorienting your holdings in anticipation of market movements is a losing gambit. Even professionals don't make the right calls consistently.

Instead, simply restore your original 401(k) mix every year or so. That's called rebalancing, and it will keep your portfolio from getting out of whack. (See "How to Rebalance Your Portfolio".) If you rebalance each time you get your annual 401(k) statement, your portfolio's risk/reward profile won't change much.

5. Relax
Your work should be minimal. You should check in every six months to make sure that your investments are fulfilling their roles. Watch out for strategy changes, manager departures, long-term performance shortcomings, and alterations to your plan options.

And don't be obsessed with the daily movements of the market--take market commentators in stride. They don't have any idea what your individual goals are. You set up your 401(k) as you did for a reason. Keep your destination in mind, and don't get wrapped up in the process of getting there.