The price of keeping your nest egg safe

When the market gets rocky, you might be tempted to protect your principal in a money market or cash fund. But look before you leap.

Question: I was advised to put all my 401(k) money in a money market account since I am 58 years old and close to retiring. Do you think this is a wise move? —M. Theriault

Answer: In a word, no.

Whoever advised you to do this, probably did so on the theory that moving your 401(k) assets into a money-market fund would enhance the security of your nest egg. And this is true, up to a point. Stashing your 401(k) in a money-market fund would insulate it from the gyrations of the stock market.

But in return for the assurance of knowing your 401(k)’s value won’t take any short-term dips, you leave yourself vulnerable to another, more insidious risk - namely, that your nest egg may not be able to support you over the next 30 or more years. Your savings will earn a return that lags inflation (as is likely the case now) or at best outpace the cost of living by only a small margin. And even that slight edge would likely disappear after you pay taxes.

In short, by focusing so much on security of principal, you increase the risk that you will run through your 401(k) stash while you’re still alive.

Of course, some people believe that it makes sense to move money - whether in a 401(k) or other accounts - out of stocks and bonds and into cash as a short-term defensive move. The idea is that you shift assets into a money-market fund when you’re skittish about the market’s prospects, and then move it back to stocks and bonds when you’re more sanguine about the market’s outlook.

The problem with that approach is that it’s easy to tell with the benefit of 20/20 hindsight when it would have been a good time to get in and out of the market, but tough to know in advance when the market is ready to fall or ready to rally. So I consider this approach little more than a guessing game.

I have a better suggestion for you: Invest your 401(k) in a mix of stock and bond funds that provides some protection against the ups and downs of the stock market, but also allows gives your nest egg a decent shot at capital growth.

There’s no single mix that’s correct for everyone. The blend that’s right for you will vary depending on your age, how much you can tolerate short-term swings in the value of your nest egg and how much you need to draw from your 401(k) and other retirement accounts after you retire.

But typically in the five to 10 years leading up to retirement, you would have somewhere around 65% of your retirement assets in a diversified group of stock funds and the rest in bond funds. You can gradually move more into bond funds every year so that by the time you’re actually ready to retire, you would have only 55% or so of your retirement stash in stocks.

You would then continue this shift throughout retirement, although even in your late ‘80s, you would still want to have roughly 20% to 30% of your money in stock funds for diversification and a bit of growth potential.

As a practical matter, once you’ve retired, you do want to keep roughly 12 to 18 months’ worth of living expenses in a money-market account. This cash stash will assure you have quick and easy access to the money you’ll need on a regular basis plus a bit extra to handle unexpected expenses that will undoubtedly crop up. You can replenish this reserve by periodically selling shares of your stock and bond funds.

If you feel you’re not up to doing all this on your own, you can always consult an adviser. Be careful, though. There are lots of people touting themselves as retirement specialists these days whose credentials may sound more impressive than they are and who may put their interests ahead of yours.

And in your case, there’s one more thing you’ll want to do if you do decide to seek help: steer clear of whoever suggested you plow your entire 401(k) into a money fund.