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As 401(k)s come back, remember fundamentals

Millions of 401(k) accounts have made up lost ground over the last 10 months.
/ Source: The Associated Press

Millions of 401(k) accounts have made up lost ground over the last 10 months. Helped by a stock market surge and continued contributions, the question now is how to keep from backsliding when market momentum slows or reverses.

With the market up more than 60 percent since it hit its low in March, the rapid rise in the market has many believing that a sharp downturn, or a correction as Wall Street calls it, is likely. The last thing investors can stomach is the market reversing itself and snatching away more of their retirement money.

So, what to do now?

Don't forget the fundamentals. Experts recommend revisiting the basic principles of investing, and offer some additional moves to consider.

A starting point for those who are heavily reliant on their 401(k) is to make sure their portfolio reflects their appetite for risk. This is a personal choice because it should be centered on how much longer you must work to meet your retirement savings goal and how comfortable you are with losing some of your money.

A key focus in making this assessment is to determine if you have an appropriate asset allocation. This means choosing a blend of stocks, bonds, cash investments and other options such as commodities or real estate. A variety of investments helps lessen risk because different assets generally don't move up or down at the same time.

The next step is to look within those asset classes to determine if you're properly diversified. This investing approach enables investors to adjust the risk in their portfolio by including a mix of a certain type of investment, say, large and small company stocks, as well as stocks from foreign and domestic companies.

Ultimately, the more time you have, the more risk you can take. This means that you can have more money in stocks because they're more volatile. The closer you get to retirement, the more you'll want to shelter from market downturns by putting it in bonds or cash investments.

After reviewing these concerns, you may find that you need to rebalance your portfolio. Rebalancing is adjusting how much money you're putting into each asset classes to fall in line with your original targets. It's necessary because over time stocks may grow faster than bonds. If you initially decided how much risk you were willing to take and chose to make 60 percent of your investments in stocks and 40 percent in bonds, you may end up with a 70/30 or 80/20 mix. This means you're taking on too much risk.

These ideas put together make up fundamentals of long-term investing. They helped millions of 401(k) investors from losing their shirts in this recession.

"Even in the worst market economy since the Great Depression, people have seen their balances move back up today to where they were before the market crashed in mid-2007," said Dean Kohmann, vice president of 401(k) plan services at Charles Schwab & Co. Inc.

The easiest way for most people who don't have time to spend analyzing the market to weigh all of these issues is to get into a target date fund. It's a mutual fund that automatically adjusts the mix of stocks, bonds and other investments as you near retirement.

Though the market continues to move upward at a fairly steady clip, you should resist making retirement investment decisions on the odds of a market correction, said Alan Skrainka, the chief market strategist for Edward Jones, one of the nation's largest financial services companies.

"Nobody knows what's going to happen in 2010. Since you can't predict, you must prepare," he said.

That means sticking to three key principles — hold quality investments, diversify broadly and hang on for the long term.

Some experts are confident the stock market will continue to gain value this year. Factors include higher trading volume driven by sidelined investors getting back in, economic activity growing and corporate profits coming in above expectations, said Art Hogan, chief market strategist for Jefferies Asset Management.

"This is going to be the first quarter in nine quarters we're going to see positive year-over-year earnings growth," he said. In addition, companies are likely to offer clearer guidance, which will likely be a positive influence on the market, he said.

One cautionary note is that inflation is a possibility for this year and you should consider commodities as a hedge against it. Hogan recommends looking into a commodity exchange traded fund. What's more, industrials, materials and energy stocks also do well in inflationary periods and selecting funds with some of these types of companies should be considered, he said.

Also be aware that a common mistake investors make after a period of high volatility is being too conservative by keeping money in Treasurys or certificates of deposit, said Jerry Miccolis, a senior financial adviser with Madison, N.J.-based Brinton Eaton Wealth Advisors. These are safe places to put money, but the return is very low. The average rate of return on a 1-yr CD is about 1.6 percent, for example.

Miccolis also cautions against being too risky by plowing too much into stocks, betting they'll continue to go up. That's a surefire recipe for disaster and a lesson many people learned over the past two years.

As the past few years have proven, reacting to short-term market downfalls and upswings can be more damaging than sticking to a long-term investment strategy. That may include some minor adjustments for inflation and other trends, but shouldn't stray from the basics of diversification and rebalancing.