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Making the Most of Your 401(k) Plan

Every choice you make involves risk, and investing for retirement is no exception. Knowing how much risk you're comfortable with can go a long way in preventing sleepless nights and uncertainty during volatile markets.

First: Pay off high-cost debt

Let's say you're carrying $1,000 of debt on a credit card that charges 1.5 percent a month on the outstanding balance. Meanwhile, you get a $1,000 bonus. Should you use that bonus to pay off the credit card, or to invest in the 401(k)?

Pay off the credit card first. If you didn't have to make a payment and just let that debt accumulate at 1.5% a month, at the end of a year it would be $1,195.62 -- for an effective rate of return (to the lender!) of 19.56 percent. Leaving it there for an additional year would raise the debt to $1,429.50. And the interest is not deductible -- you pay it with after-tax dollars. Not even a good 401(k) with a generous company match will keep up with that for long.

Once you're not carrying high-cost debt, you're ready to invest in your 401(k).

Next: Be comfortable with your 401(k) investments

Selecting suitable investments should be done with care and understanding. To make sound choices, be sure to ask questions about the mutual funds available in your 401(k) plan. Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges and expenses carefully before investing. The prospectus, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest.

Your retirement funds should be viewed as long-term investments, and capital growth is an important ingredient for long-term investment success. However, one year's outstanding results for a particular security may not be repeated the next year. So you'll need to make your selections with a view to consistent long-term performance.

For each investment choice you're considering, read the information carefully. While many offering documents can appear forbidding, they contain a wealth of information about performance and risks.

Levels of risk

Investment risk should be evaluated with an eye on the amount of time you have before you plan to retire. As a rule of thumb, if you're more than 10 years from retirement, the percentage of non-stock investments in your portfolio should be about half of your age. For example, if you're in your twenties, a portfolio with about 90 percent equities and 10 percent cash and bonds may provide the right combination of growth and safety.

As you get older, you may need to have less of your money in stocks. In your 50s, for example, you may want to raise your non-stock proportion to 25 percent. And once you're within 10 years of retirement, you may want to raise the non-stock proportion faster. However, over time stocks have outperformed bonds, so you may want to keep some of your money in stocks to provide the potential for capital growth and help protect your portfolio from erosion by inflation. Past performance is no guarantee of future results.

Most 401(k) retirement plans offer a variety of mutual-fund choices (each of which is itself diversified over a broad range of securities) offering different investment objectives and styles. You can adjust your portfolio by investing portions of your retirement dollars in various funds. Using several different types of funds may add an extra dimension of safety to the diversification within each fund. For example, if you're just starting out in your career, you might invest 60 percent of your assets in an aggressive growth fund, 20 percent in a balanced fund (one that invests in both stocks and bonds), 10 percent in a global fund, and 10 percent in a bond fund.

Review your portfolio and risk tolerance every year or so

As your circumstances change, your goals will change too. And even if your goals remain the same from one year to the next, you'll need to make sure your portfolio is moving in the right direction.

Much can be learned from reading the annual and semi-annual reports of the investments you've chosen for your plan. These reports typically show the specific companies, by industry group, in which you are invested -- as well as performance figures and information about the managers' strategy for the future. Maintain files of your quarterly retirement-plan statements. This will help you see how your account is performing over time and make adjustments as needed.

If you like, you can also track daily results by checking the net asset value (NAV) of each of your investments in your local newspaper or financial periodicals like the Wall Street Journal.

Remember the key things to consider in order to effectively manage your investment risk:

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