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Interest rate changes can affect 401(k)s 9/22/2004 NEW YORK (AP) — With the stock market just sputtering along this year and the Federal Reserve raising interest rates, it may be time to review the holdings in your 401(k) retirement account. Stocks aren't expected to do as well this year as they did last. The Dow Jones industrial average, for example, is down some 2 percent so far this year after rising more than 25 percent in 2003. Bonds, meanwhile, are sensitive to actions by the Fed, which on Tuesday raised the target for the federal funds rate to 1.75 percent from 1.50 percent. Generally, as interest rates rise, the yields on bonds rise and their prices fall. Experts say it's not necessary for most workers to make drastic changes to their 401(k) portfolios, especially if they have diversified stock and bond holdings. "It's important to remember that you're investing for the long term, for retirement," said Steven E. Norwitz, a vice president at T. Rowe Price Associates, an investment management firm based in Baltimore. "You shouldn't be making decisions based on short-term market developments." Still, there are ways to tweak 401(k)s to deal with current conditions. J. Michael Scarborough, chief executive of the Scarborough Group in Annapolis, Md., which manages retirement accounts, noted that bonds are especially vulnerable to interest rate changes. Long-term bonds, with maturities of up to 30 years, can drop steeply in value when rates are rising. "We're not recommending getting away from bonds, but shortening the maturities of the bonds you hold is a good idea," he said. Scarborough noted that most 401(k) plans offer three or four bond funds, and said that savers should look for those that hold short- to intermediate-term bonds, which are less volatile in a rising rate environment. Scarborough also discourages savers from trying to avoid the current stock market malaise by moving to money market funds and other cash-like instruments. Staying in the market, he said, "will put them in position for 2005, which should be a good year in the markets." Financial planner Sheryl Garrett, founder of the fee-only Garrett Planning Network based in Shawnee Mission, Kan., agrees that savers should stay in the stock market. "I'm seeing way too many people who overreacted from the bear market in 2000, 2001 and 2002," she said. "They missed out on the gains in 2003, but they're still sitting in too conservative an allocation because they worry about taking a beating again." She recommends that "even the most conservative investor should have 20 percent to 30 percent in stock," with holdings diversified among funds that specialize in large companies, small companies and even international companies. Savers uncomfortable with their bond fund holdings — especially those approaching retirement in the next few years — might consider moving that part of their 401(k) portfolios into stable value funds, Garrett said. Stable value funds invest in high-quality, short-term bonds and use special insurance contracts to keep asset values stable amid interest rate swings. A worker approaching retirement "would probably prefer to have 4 percent from a stable value fund than a drop in a bond fund," she said. Norwitz of T. Rowe Price noted that many savers don't like to deal with rebalancing their accounts. These people, he said, can benefit from the new asset allocation funds available from all the major mutual fund companies, including Vanguard and Fidelity. With these so-called targeted maturity funds — known by various names such as lifestyle funds or life cycle funds or retirement date funds — workers select a fund with the year closest to their expected retirement date. The fund managers then take on the responsibility of shifting the asset mix as the worker approaches retirement. T. Rowe Price's Retirement 2010 fund, for example, has 67 percent in stocks and the rest in bonds and other fixed-income investments, while its Retirement 2040 fund has 90 percent in stocks and 10 percent in fixed-income.
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