Are you retiring in ten years or less? Here's what to do with your 401(k)

This post is a follow-up to an earlier post by retirement expert Dan Solin on what you should do with your imploding 401(k) plan.

If you are retiring in ten year or less, I can understand how worried you are about the value of your 401(k) investments. Many employees tell me they can't bear to look at their statements.

Here's what to do if you are going to depend on your 401(k) for living expenses when you retire.

In the investing world, ten years is a long time horizon.

I looked at 481 monthly rolling ten year periods over fifty years, from January, 1958 to December, 2007. If you were fully invested in a globally diversified portfolio of stocks during that time period, how many ten year periods do you think you would have had negative returns?

How about never!

The average annualized returns of this portfolio were over 13%. The lowest returns were still over 5%.

I appreciate that historical data is not predictive of future returns and it may well be that it is "different this time," but those are pretty impressive facts.

If you are persuaded by this data, the asset allocation of your 401(k) should have 70%-100% stocks with the balance in bonds.

As retirement nears, you will have to make adjustments to your asset allocation, because your tolerance for risk will diminish. Here are some good rules of thumb.

When you are seven years from retirement, reduce the stock portion of your 401(k) to 60% or less. The average annualized returns for this portfolio were in excess of 10%. The worst returns were in excess of 2%.

When you are five years from retirement, reduce the stock portion of your 401(k) to 35% or less. The average annualized returns for this portfolio were in excess of 8%. The worst returns were in excess of 3%.

If you have less than 4 years from retirement, you have a dilemma.

The only way to keep pace with inflation and taxes is to have some exposure to the stock market. Many pre-retirees and retirees are understandably concerned about market volatility. They invest in "risk-free" investments like insured CDs and Treasury Bills. These investments currently pay low interest rates, virtually guaranteeing a loss after inflation and taxes.

Many financial planners believe that pre-retirees and retirees should have at least 35% (or more) of their portfolios invested in stocks at all times.

If you follow this advice, remember that you may have to hold on during stomach-churning bear markets like the one we are currently experiencing.

Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, June 24, 2008)