For Chris McCullough, it was the end of a lovely dream. At 61, she works for a nonprofit health system in Cleveland and sees all around her the many risks that imperil life. So she chose what she thought was a careful course for her retirement plan--picking "safe, blue-chip growth funds" instead of high techs. They peaked at $40,000, and you know the rest. "I was freaking out," she says. When her "safe" funds tumbled to $25,000 last month, she threw in the towel and switched to bonds. Now switch to aggressive investor, Liz Vargas Johnson, 40, an administrative assistant in Ellicott City, Md. Her small contributions grew to $12,000 before the bear chewed up 70 percent of the money. Today, she's frozen in place, confused by what she hears. "Invest, don't invest. Move your money, don't move it. I don't believe anybody anymore," she complains. Johnson has canceled her regular 401(k) contributions, opting instead for money in the bank.

And so it goes. Just when Americans thought they were headed for easy street, they got slammed by the deepest bear market since the late 1930s. Worse, their rock-star CEOs skimmed off the profits, leaving the little guys holding the bag and the 401(k). Suddenly, their retirement plan feels like a hoax.

It's not. The 401(k) and similar plans have become the new "pension" for 29 million workers--offering them the best way of supplementing their Social Security checks. The government pours $44 billion in tax subsidies into these plans, says economist Teresa Ghilarducci of Notre Dame. We've got $1.6 trillion of our future invested there.

But after the stock-market dive and the Enron disaster, a disturbing question bubbled up. How capable is the American public of managing these enormous sums? During the bubble years, investing looked like a piece of cake. Now savers are billions of dollars behind with no road map for catching up. "I'm not sure that God watches the Dow or the Nasdaq," Johnson says, "but if he does, I hope he's listening to me."

Congress is listening, or pretending to. Lawmakers strutted around the Capitol after the showy Enron hearings, promising to strengthen 401(k)s. Then the House punted, with little reform at all. The Senate will take up a stronger bill next month, but big businesses is lobbying heavily against it.

Change is essential, now that 401(k)s have become the new safety net. We need to be protected from our own mistakes. Back in 1974, Congress rescued workers who were losing their pensions in ill-run or bankrupt plans. That cycle has come around again. Here's what to do:


When the market was booming up, everyone wanted more choice, choice, choice. Investments became like breakfast cereals--the more varieties, the better. In real life that's a bad idea. The more choices you face in your 401(k), the harder it becomes to decide.

Most people spread their money over just three or four funds, no matter how many options they have. But the greater the choice, the greater the risk that you'll pick a poor investment mix.

Memo to employers: two models exist for a "perfect" 401(k). One is the Thrift Savings Plan, run for federal workers. Until last year it offered just three broad-based funds--for big stocks, bonds and Treasury securities. In 2001, it added small stocks and international stocks. This kind of plain-vanilla approach saves you from obsessing over six different growth funds. Instead, you focus on the decision that matters most to your long-term success--namely, how much of your money to allocate to various types of assets. On average, federal workers have chosen well. In 2000, they allocated 57 percent to stocks and the rest to bonds and Treasuries.

My other favorite plan is the $265 billion teacher's retirement fund, TIAA-CREF. Until 1988, it offered just two funds--a fixed-income annuity with a minimum guarantee and a stock fund invested roughly 80 percent in the United States and 20 percent abroad. Let's face it: what more do you really need?

TIAA-CREF members did indeed agitate for a little more choice. Today the plan offers 10 funds, including a growth fund, a socially responsible fund and, since 1995, a real-estate fund. Nearly 84 percent of the money remains in the original two, although the investment du jour is clearly real estate. Two years ago only 10 percent of participants put any money there. Now 22 percent are trying their luck. (These aren't real-estate stocks, by the way. They're $3.5 billion worth of direct development projects that TIAA participates in.)

Plans that don't or won't offer plain-vanilla funds should give more thought to single-choice portfolios. These are often called lifestyle or age-based funds. You get a specific mix of stocks and bonds that work for people of your age and attitude. The portfolio can be conservative or aggressive. An investment manager tweaks the fund from time to time, so it always tracks its original investment goal.

So far, lifestyle funds haven't proved popular with employees. But that may be due to the fact that they're not very well explained. They're not supposed to be one of several funds you own--you can use them as your only fund, with a mix of stocks and bonds designed by an expert for people just like you. In the 401(k) brochure, lifestyle funds should be sold, in capital letters, as the simplest, most comprehensive choice.

It's just plain wrong for 401(k)s to offer narrow industry funds such as biotech or housing stocks. From time to time, these sectors blow themselves and their investors up. Plans shouldn't lead you there.


I'm coming to think of company stock as a neurosis. Some sort of unhealthy attachment. A recent study by the Boston Research Group finds that half the people in 401(k)s think their company stock is no more risky than a safe money-market fund. It's as if they never saw the retirements wrecked by Enron, Lucent, WorldCom, Tyco, Xerox and the enormous graveyard of high techs. In truth, no individual stock--not even the most famous blue chip--is safer than a money fund. The more you own of a single stock, the more potential trouble you're in, especially if your job is tied up with that company, too.

But Americans are a long way from feeling this critical lesson with their gut. Half of all 401(k) participants now can invest their contributions in company stock. Workers at larger companies keep an amazing 26 percent of their assets there.

Sometimes they can't help it. Their companies may stuff their plans with stock as a matching contribution and not let anyone sell until age 55. But what about people who don't diversify even then? A Hewitt Associates study of big-company plans found that, of the participants 60 and older, nearly one fifth kept all their balances in the stock.

Even after Enron, employees barely stirred. "It's inertia," says Shlomo Benartzi, professor of business at UCLA. Once employees have made their investment choices, they're usually slow to change. That's especially true when a stock has doubled or tripled in value--which of course is exactly the time to start taking money off the table.

If I were tsarina, I wouldn't let anyone hold more than 10 percent of his or her 401(k) money in company stock. That's the legal limit for traditional pension plans, in order to keep lifetime payouts safe. Why should people in the "new pensions" be free to feed their own investments to the chipmunks? I'd also require that your 401(k) statement contain a surgeon general's warning. "Caution: too much company stock can be hazardous to your wealth."

Good-guy companies realize that they shouldn't be putting loyal workers at risk. They match your contributions with cash or let you switch out of a stock contribution at any time. Then there are the rest--the CEOs who put their workers' interests last. They want to keep jamming you with stock because it's a cheaper way to give.

When Enron collapsed, Congress summoned workers to tell their sad stories about losing money in the stock. But with the TV cameras gone, don't expect the Hill to do anything much. Legislators and lobbyists shot down the idea of putting a limit on the company stock in your plan. Sen. Edward Kennedy suggested an either/or solution: the company could match your contribution with stock or you could buy it yourself--but you couldn't have both. Even that modest cap looks dead. At most, a new law might free you to sell matching stock if you've been with the company for three years.

Benartzi has a great idea that I wish some companies would take up. He calls it the Sell More Tomorrow plan. Any employee loaded up with company stock could arrange to have the 401(k) sell it gradually --maybe at the rate of 5 percent a month. That way, it's easier to cut the tie.

Matches in company stock aren't all bad. Jack VanDerhei of Temple University says that a match encourages workers to own more equities than they otherwise would. That gives them a modestly better return over the long run--always assuming that the company doesn't go broke.


Once your money goes into a 401(k), it ought to stay. You shouldn't be able to turn around and borrow it back. Lockups may sound draconian at first. But you're not allowed to borrow against an Individual Retirement Account, and nobody kicks about that. Employers (or government) should shut loans down.

Loan plans got started as a way of luring lower-paid workers into 401(k)s. Higher-paid people need them there. By federal law, the higher-paid can't contribute the maximum to their own 401(k) accounts unless the plan is generous enough to attract average people, too. Loans turned out to be one of the ways of getting them there. The average borrowing rate today has reached 18 percent of all participants--but that climbs to 23 percent among those with low to moderate incomes. That partly defeats the purpose of having a savings plan.

Loan options can also create a tunnel into workers' retirement funds. During the bubble years, I heard stockbrokers urge prospective clients to borrow from 401(k)s in order to "double their money" in tech stocks and dot-coms. Pity those who did.

Loans against your retirement plan can come back to bite you if you leave the job. Ex-employees normally have to repay within three months. If you can't, your loan will be treated as a cash withdrawal. You'll owe income taxes on the sum, plus a 10 percent penalty if you're under 59 1/2.

The loan question hints at another big issue that's coming down the pike. What happens when you retire or leave the job and a lump sum of money passes into your hands? A 401(k) encourages you to save; its investment options can help you deploy your money well. But as soon as you take your cash away, you'll find the financial industry ready to pounce--brokers, insurance agents, planners, accountants, investment advisers, plus plenty of crooks. You're no longer protected once you leave the regulated 401(k) world. "It's a gaping hole," says TIAA-CREF's Douglas Fore.

Any way you look at it, money outside a well-structured plan presents you with a major risk. You can figure out how to repay a loan and budget for it. But you don't know how long you're going to live and whether your nest egg is going to last.

Sponsors of 401(k) plans may think that this is none of their business. They help you accumulate money, then say goodbye and good riddance. Dallas Salisbury, head of the Employee Benefit Research Institute, calls that incredibly shortsighted. Older people will become one of America's prime consumer markets--so it's critical that, as a group, they remain economically secure. I'm not saying that this is a job for the private sector alone. But plan sponsors can do more than just plug the loan gap that lets retirement savings leak away. For example, they could look for seamless ways of rolling lump-sum payouts into low-fee lifetime-income plans--both investments and annuities.


By advice, I mean real advice. A place, a phone number, a person, a Web site where savers can ask the essential question "What should I do?" Brochures are fine--you get interesting pie charts, wise sayings and general information about the options in your plan. For some people that's enough. But brochures don't address the most critical issues, such as the range of returns--high and low--that you can expect from various combinations of stocks and bonds. Most of all, amateurs like us find it hard to grasp the level of risk we're taking on. And I don't mean just high risk, as in owning all growth funds all the time. It's also risky to bury yourself in fixed-rate investments that won't earn much after taxes and inflation.

Sponsors of 401(k)s are generally willing to provide advice. But first they'd like Congress to pass a law preventing them from being sued if the advice goes wrong. This has opened a new can of worms--namely, who should the adviser be? The House thinks it's OK to use the same company that provides the mutual funds for the 401(k). To me that's a conflict of interest, with plenty of dangers down the road. The Senate bill would require independent advice from companies not involved with the funds.

You'd have to pay for the advice either directly or through the plan. Employers might cover the cost by shaving a few dollars from the company match. That would be OK if you earned the money back by choosing better investments than you had before. "The question is whether employees are willing to make the trade-off," VanDerhei says. Of all the options, Web-based help might cost the least. Many adept employees already use these sources well. But others trust only advisers they can speak to in person, and that's an expensive way to go. Plans might find ways of cutting costs elsewhere, so they could afford to bring real planners into the room.

You have to wonder how often questions like these come up among the trustees who oversee your 401(k). They're usually management people from the treasurer's or human-resources office. And they may have many interests on their minds other than yours. Fees are one obvious area. To save money, companies have been shifting more of the administrative expenses onto the plan itself. You don't see it because the costs aren't made clear. But they reduce your gains.

Another major conflict comes up in 401(k)s that own company stock. If the stock is plunging (think Enron here), should the trustees sell? They're supposed to be operating on your behalf, but a human-resources VP isn't likely to tell the boss that she wants to dump the shares.

Every 401(k) should have a trustee who represents workers' interests, Ghilarducci says. That's one of the Senate proposals that business hopes to kill. But why shouldn't you have a say in a matter so close to your long-term financial interests? Good worker reps would almost certainly push employers to simplify plans. They'd make the company disclose the hidden fees you pay. You'd see fewer plans filled up with company stock, and cozy relationships with the providers would be harder to conceal. Being tsarina, I'd require all 401(k) trustees to sit through a course on their responsibilities. Workers' futures are at stake.


It's no fun losing money in your 401(k). But the far greater problem is that people aren't saving nearly enough to start with. Nearly 9 million workers who are offered retirement plans don't bother to join--especially the young or those with lower earnings. "We need to spend more energy on getting people started and less on those who have savings already," Salisbury says. "It's in the national interest for retirees to have more than Social Security to live on."

Companies could help in this effort by signing up workers for 401(k)s automatically. An employee could always opt out, but thanks to inertia, most would stay. I can see these 401(k)s taking 3 percent from each paycheck, at the start. The company could add a cash match and invest the total in a fixed-interest or balanced stock-and-bond fund. As the worker got raises, the percentage contributed might gradually rise. This isn't a far-out idea, by the way. A handful of companies, including McDonald's and Motorola, are providing automatic accounts even as we speak.

One of the puzzles, of course, is where to invest the money when the employee hasn't expressed a choice. The Labor Department could help out by offering guidance on what might be considered prudent. The department has already taken a positive step in this direction by approving the concept of managed accounts for 401(k)s. Once these plans get cranked up, independent advisers will offer investment portfolios within 401(k)s, which they'd manage for you. Workers signed up automatically could be assigned to these plans, too. We know for sure that forced savings work. Many of you, for example, have money taken from bank accounts each month and swept into a mutual fund or Individual Retirement Account. Social Security, a mandatory plan, keeps millions of aging Americans out of poverty. There's no reason not to target people who think they can't afford to save. Imagine that, over a lifetime, a person with modest earnings acquired, say, $40,000 in a forced-savings account. If that sum were annuitized at current rates, men would pick up an extra $294 a month at 65; women would get an extra $277. That's a lot of money to someone who would otherwise just scrape by.

No one has named me tsarina yet, which is undoubtedly a relief to the companies that don't want workers poking into their policies on 401(k)s. The White House is also arguing for least possible change. The president thinks that you want some CEOs in jail but aren't much concerned about pension reform. When the Senate bill comes up in September, we'll see the limits of what can currently be done. In the meantime, here's how to improve your plan yourself:

OPEN YOUR STATEMENTS: Take another look at what you own. You won't get anywhere by holding your breath and pretending that everything will be all right.

SELL COMPANY STOCK: Diversify, diversify. Even if you love the stock, keep no more than 5 percent of your money there. If you have a lot of stock that you're not allowed to sell, form a committee to meet with management. I don't care how "good" the company is. It's not fair to force the workers to bear that high level of risk.

SHIFT TO BROAD STOCK FUNDS: If you're lucky, your plan has an index fund that follows the stock market as a whole. Otherwise, split your equity money between a growth fund (for fast-growing companies) and a value fund (which buys stocks cheap).

DON'T FORGET BONDS: When stocks were hot, I was considered a nut for talking about bonds. But as you now know, your investments need a security net. And they still will, even if stocks have started up again. We all take risks in life, but the older we get the more we appreciate having safe corners, too.