The good news and bad news about your nest egg: You can find ways to make it last, but it’s not going to be pretty.

I’m retired and have lost a third of my savings and a third of my monthly income. I don’t have earnings, so I can’t add new money to my retirement portfolio. I also don’t have enough time to wait for a  market recovery to recoup my losses. What can a retiree in my position do? - B.P. Ocala, Fla.

I’m not going to sugarcoat my answer. Fact is, you and other retirees who have seen the value of their retirement portfolios decline substantially over the past year are in a tough position.

The problem comes down to this: The double-whammy of investment losses and withdrawals from your nest egg to pay living expenses dramatically increase your chances of running through your retirement savings prematurely, which is something you obviously want to avoid.

The good news is that there are some moves you can take to reduce your odds of outliving your savings. The bad news is that those moves aren’t very appealing.

To put it bluntly, to assure that you don’t run out of money before you run out of time, you may very well have to scale back the retirement lifestyle you had envisioned, at least temporarily.

In this column, I’ll explain what retirees and people on the verge of retirement who have suffered sizable losses in their portfolios need to do to salvage their retirement. Indeed, even people who haven’t incurred big losses may also want to read on so they’ll know what to do should they find themselves in that position later on.

But before I get to what you should do, I want to point out that many people facing this problem may be focusing their attention in the wrong place. Since it was the huge drop in stock prices that decimated their portfolios and put them into this financial bind in the first place, many retirees have naturally assumed that the answer to their problems lies in changing their investing strategy.

Toward that end, many people have moved much, if not all, of their investment stash to “safe” alternatives such as stable-value funds, money-market accounts and CDs in an attempt to staunch the bleeding in their retirement portfolios.

Revisiting your investing strategy is certainly appropriate given what’s been going on in the financial markets lately ( although as I’ve noted before, plowing all or nearly all of your retirement savings into low-yielding secure options can backfire over the long run.)

But you really need to concentrate your attention on withdrawals. Specifically, you must figure out how much you can reasonably pull from your retirement accounts each year given their current value without draining them prematurely.

And as unpleasant as the prospect may be, you may very well have to withdraw less than you had planned – perhaps much less – in  order to have a realistic shot at making your savings last throughout retirement.

Here’s why.

A variety of studies have demonstrated that if you limit the amount you withdraw in the first year of retirement to 4% or so of your portfolio’s value and then increase that amount each year for inflation to maintain your purchasing power, you’ll have roughly a 90% chance of your money lasting at least 30 years.

But those odds decline dramatically if you sustain big investment losses early in retirement. For example, recent research by investment firm T. Rowe Price shows that if a retirement portfolio invested 55% in stocks and 45% in bonds looses 20% the first year of retirement, your odds of being able to pull an inflation-adjusted 4% of the portfolio’s original value each year drop from 90% to about 60%.

And if the portfolio takes a 30% hit, the odds drop to about 40%. The reason is that the combination of steep losses and withdrawals so depletes your capital that your portfolio can’t fully recover even after the market rebounds.

Which means that if you want to reduce the odds of your savings running dry too soon after a major setback, you really have little choice other than to reduce the amount you withdraw from your savings.

The question is how much should you cut back?

It’s hard to give a definitive answer because the right withdrawal amount depends on a variety of factors, including how large a loss you’ve experienced, how quickly you expect the market to recover, how many years you want your money to last and how much assurance you need that it will last that long.

But T. Rowe’s research suggests that the cutbacks may have to be substantial. Indeed, if your portfolio’s balance has dropped by 20% to 30% and you want a 90% chance that your savings will support you for at least another 30 years, you should probably scale back your withdrawals to about 4% of your portfolio’s new reduced balance – that is, it’s value after the losses.

Let’s say, for example, that going into retirement you had a portfolio worth $1 million from which you had planned to withdraw 4%, or $40,000. But if your portfolio declined in value by 20% to $800,000, instead of withdrawing $40,000, you would instead withdraw $32,000, or 4% of your portfolio’s reduced balance of $800,000. And if your portfolio dropped 30% to $700,000, you would withdraw just $28,000.

You could pull out a bit more – $35,000 and $30,000, respectively in the example above – but then you would have to forego increasing your withdrawal for inflation the first five or six years of retirement. Either way, we’re talking a big reduction from your planned $40,000 initial withdrawal.

Of course, you don’t want to be making cutbacks for your situation based on one hypothetical scenario. If you’re well into retirement, for example, you don’t need your savings to last 30 years. So you may not have to reduce your withdrawals nearly as much. The same goes if your retirement investments haven’t taken a very big hit.

So how can you tell out how much you may need to trim withdrawals given your age, the beating your portfolio has taken and the level of assurance you want that you won’t outlive your savings?

One option is to go to an online tool like T. Rowe Price’s Retirement Income Calculator. You plug in such information as the current value of your savings, how your money is invested and the amount you plan to withdraw, and you’ll get an instant evaluation of whether your savings will last as long as you’d like. You can then see how your prospects change by lowering your withdrawals.

Or you can have a financial adviser run the numbers for you. Any competent adviser should be able to do that, but you want to be careful you don’t end up with someone who sees this analysis as an opportunity to sell you high-priced investments you don’t need. (For the names of reputable advisers, you can click here and here.)

Of course, determining how much you can reasonably withdraw from your savings is one thing. Living on that amount is another. I’m sure that to do so many retirees will have to make painful adjustments to their lifestyles. And some people may simply may not be able to get by on significantly smaller withdrawals.

So I’m not suggesting this will be easy. But whether it’s cutting discretionary spending whenever possible, working part-time, downsizing or taking out a reverse mortgage or even reducing withdrawals by a smaller amount than suggested, you do what people have always done in difficult situations: you make the compromises you can.

It’s possible this retrenchment will be only temporary. Depending on the losses you sustained, how quickly the economy and the financial markets recover and how robust that recovery is, you may be able to boost withdrawals later on so that you can once again live the retirement you envisioned.

For now, though, it’s crucial that retirees and near-retirees do the sort of analysis I’ve described ASAP. Because if you simply pull money from your savings based on the income you would like to have versus the withdrawals your portfolio can actually support over the long term, you may find yourself in even bigger hole later on, recovery or no.

You can always make a case to regularly retool your account – and this year, it’s especially important.

Normally I rebalance my 401(k) at the end of the year. But considering the losses I have in my account, do you think I would be better off waiting for the market to stabilize before rebalancing? - Samuel Fritts, Cary, N.C.

If you’re a movie buff, you probably remember that famous scene in “The Graduate” where Benjamin Braddock, played by Dustin Hoffman, is wandering through a crowded party celebrating his college graduation when a friend of his parents, Mr. McGuire, pulls him aside to offer some career advice.

“I just want to say one word to you. Just one word. Are you listening?” Weighty pause. “Plastics.”

Clearly, there’s no single word of advice that can address all the issues investors face in today’s perilous environment. But if I did have to limit myself to one word at this time of year, this one would certainly be a candidate: Rebalance.

Yes, I know that rebalancing has become the financial equivalent of your mom’s “eat your vegetables” dictum, a mantra repeated so often that we really don’t hear it anymore. Which is why I often think of rebalancing as the Rodney Dangerfield of investing strategies – it gets no respect.

Truth is, though, that selling assets that have outperformed and plowing the proceeds into those that have lagged (or investing new money into sagging investments) is an easy and effective way of maintaining the right balance between risk and reward in your portfolio.

Quite simply, rebalancing prevents your portfolio from getting too risky when the market is soaring (thus setting you up for a nasty shock when a setback occurs); and it stops your portfolio from becoming too conservative when stock prices fall (leaving you unprepared for a rebound).

And if that’s not benefit enough, research also shows that rebalancing can improve your portfolio’s performance over the long term by smoothing out its ups and downs.

But as solid as the case is for rebalancing on a regular basis, I think it’s especially important to do it this year.

Why? Well, given the beating the stock market has taken this year, the balances of the stock funds in your 401(k) and other retirement accounts have probably declined significantly. Which means that when you rebalance, you will have to shift some of your 401(k) money into those beaten-down stock funds.

I can already imagine you saying, “What? Move money into stocks now? Are you bonkers? That’s the last thing I want to do.”

That reaction is understandable. The stock market has been hammered mercilessly, and no one is sure when the devastation will end. So the natural impulse today – even for someone like you who actually knows he should rebalance – is to stay away from stocks until there’s some assurance that they won’t fall even further. Hence your desire to hold off rebalancing until the market “stabilizes.”

The problem with acting on that impulse to postpone rebalancing until you feel better about doing it is that you’re eliminating one of the main reasons to rebalance: it forces you to buy assets when they’re unpopular.

If you were to always delay rebalancing until a sinking investment recovers – whether it’s stock funds or any other part of your portfolio – you would essentially be buying in mostly when that asset’s price is rising. Do that, and your long-term returns will suffer because you won’t scoop up shares at depressed prices, which is precisely when they’re more likely to deliver superior long-term gains.

In other words, by second-guessing your normal rebalancing routine, you’re undermining the very purpose of the exercise in the first place, which is to take the guesswork and emotion out of managing your portfolio.

That said, it’s also important to remember that rebalancing is a tactical move that makes sense only if you’re doing it as part of an overall plan. Rebalancing is meaningless if you haven’t set an appropriate asset-allocation strategy for your retirement accounts.

After all, if you don’t maintain a mix of stocks and bonds that’s suitable given your age and risk tolerance for your portfolio, then you have nothing to rebalance back to. And if you’ve set an asset allocation that’s inappropriate, then rebalancing back to it wouldn’t do much good either.

Unfortunately, whether it’s because they had no plan to begin with or were unrealistic in setting their stocks-bonds mix, many investors went into this downturn more heavily invested in stocks than they should have been.

The Employee Benefit Research Institute estimates that at the beginning of 2007 nearly 40% of 401(k) participants 56 to 65 years old had 80% or more of their accounts invested in stocks. That’s a pretty high-octane mix for people nearing retirement.

So before you do any rebalancing, you’ll first want to re-assess your investing strategy to assure that you have a mix of stocks, bonds and cash in your 401(k) that’s appropriate for you. (For help creating a suitable blend or evaluating the one you have, you can check out our Ultimate Guide to Retirement.

Once you’ve done that, though, you’ll want to go ahead and rebalance as planned, even if it’s emotionally difficult to do so. Otherwise, you’ll be abandoning your regimen just when it’s likely to do you the most good.

If you can learn from the mistakes of others, now is a great time to be an investor.

Question: I’m inexperienced when it comes to investing, but I want to build a more secure financial future. What tips or suggestions do you have for a young investor like me? —Caleb Bond, Denver

Answer: It’s a great time to be starting out as an investor. Yes, I know that might sound odd, given that the market and the economy are in shambles. But the fact that people are so fearful and the outlook is so uncertain can also have its advantages.

For one thing, much of the excess has been wrung out of stock prices over the past year or so. And while this hardly insures a quick rebound, the money you invest today is much more likely to earn a higher return than if you had invested before the meltdown.

Even more important, though, is that you now have a better sense of the real risks of investing. People who gain their investing experience during bull markets can easily be lulled into a false sense of security. They know that severe downturn occur and maybe could occur again, but the possibility of one happening to them seems remote.

Today, however, all you’ve got to do is look around you to see that risk is real, it can be devastating and it must be respected.

That said, there’s also the danger that someone surveying today’s scene might take away the wrong lessons. Already, some people are concluding that stocks, or financial assets in general, are just too risky. When it comes to important goals like retirement, they say, the experience of the last year or so shows you should stick to the most secure investments, FDIC-insured CDs and the like.

But that’s an overreaction. Risk is a natural part of investing, a part of life, for that matter. Eliminate it and you eliminate opportunity. The key is to understand how much risk you’re taking and manage it.

With that in mind, here are four lessons I think beginning investors should take from the financial crisis and apply to their investing decisions now and in the years ahead. Come to think of it, I think experienced investors should consider them as well.

Financial success isn’t just about investing.

We kind of lost sight of this fact because returns on financial assets had been so good from the early 1980s through the late ‘90s. And even after the dot-com bust we had another five-year bull run in stocks, not to mention heady gains in the real estate market. It became easy to assume that we could achieve financial goals like a secure retirement with a minimum of savings because we could count on the compounding effect of years of high returns.

That was always an unsound strategy, but it’s only now becoming clear how flawed. In fact, as a study by Putnam investments showed a couple of years ago, saving is just as important for building wealth, if not more so. We can’t be sure of the size of the investment gains we’ll earn, and we don’t have nearly as much control over them as we used to think. But we have much more control over how much we save.

And by saving more, we gain two big advantages: we don’t have to invest as aggressively to build a retirement nest egg or reach other financial goals; and, by socking more money away, we’ll have more of a cushion in the event of setbacks in the market.

Simplicity is better than complexity.

If I could ban two words from the vocabulary of investors, it would be these: “sophisticated investing.” I think more harm has been done by investors trying to boost their returns by creating arcane investing strategies or buying complicated investments they don’t understand than all the investment con men and rip-off artists combined.

I don’t want to sound like a Luddite. I’m all for using tools, calculators and software to help you create a retirement plan and an investing strategy. But you’ve also got to maintain a healthy sense of skepticism about how much fancy algorithms and intricate computer simulations can do.

Fact is, the more complicated your investing strategy is, the more things there are that can go wrong, and the harder it will be for you to monitor and maintain it. A simple mix of stock and bond mutual funds may not be the sexiest strategy around. But if you use good common sense in putting that mix together – i.e., you diversify broadly as we recommend in our Asset Allocator tool – it will serve you well over the long term.

Allow for the possibility you may be wrong.

One of the most notable features of the real estate bubble was how sure people felt that prices would continue to go up, up, up. At the peak of the housing mania, I remember getting emails from firms that were inducing individuals to open self-directed IRA accounts so that they could then invest their IRA money in real estate. I wrote a column at the time suggesting that this might be a sign that the real estate market was getting frothy and warning people about staking their retirement on the housing market.

I got a lot of feedback on that column, alas, most of it from people who wanted to know how they could get in touch with those firms that could help them get rental houses into their IRAs. And although I and others pointed out that house prices had gone down in the past and stayed down for quite a while after big run-ups, no one seemed to believe that it could happen again.

Which is why it’s always important when you’re investing to give yourself a reality check. Are your assumptions realistic? Is there something you’re overlooking? Could you be wrong? What would the fallout be if you are? And, perhaps most important, are you interested in this investment because it fits in with your overall strategy or because it’s the investment everyone is talking about?

Don’t get too euphoric during upswings or depressed during downturns.

When things are going well and the economy and the markets are on a roll, it’s easy to let the excitement cloud your judgment. After all, everywhere you look – the double-digit gains in the fund listings, the upbeat news in the newspaper’s business section, the cheerful banter on cable TV financial shows – you get positive reinforcement. You almost can’t help but believe that the good times will continue to roll.

So you begin to boost the percentage of stocks in your portfolio and put more money than you should into hot investments that now seem like good bets, such as emerging market stocks. In other words, you begin taking on more risk, although, you probably don’t see it that way. How can investing be risky when it seems the market only goes up?

This process kicks into reverse, of course, when the markets and economy change course and begin falling apart. Then the prevailing gloom and doom dominates your thinking. Everywhere you look – the double-digit losses in the fund listings, the downbeat news in the business section, the somber mood and dire pronouncements on the cable TV financial shows – you get negative reinforcement.

You become convinced that the hard times will get even harder. So you sell out of stocks and move into safe-haven investments you sneered at during boom times – bond funds, money-market funds, stable-value funds, even CDs. And you no doubt see this as a move to reduce risk. After all, aren’t you safer getting out of the market when it only seems to keep going down?

But there’s a risk here too: you may be selling at the worst time and positioning yourself to miss the recovery when it occurs.

These feelings and reactions are natural. We’re human. But it’s no news flash that markets and economies move in cycles. That we go through periods of excess on both the upside and downside. We’ve gone through such episodes before and we will again. So ideally you want to set a strategy that factors in such fluctuations, and then avoid the urge to abandon your strategy when your emotions are screaming you to do so.

I can’t guarantee that steering clear of the euphoria that leads to aggressive investing at market peaks and avoiding the despair that causes you to be too conservative after the market falls apart will assure you’ll earn the highest returns or sidestep big losses. But by doing so, you’ll probably be less vulnerable heading into downturns, and better positioned to take advantage of the upswing when it occurs.

Question: Now that the stocks in my IRA have taken a big hit, does it make sense for me to convert to a Roth IRA? I anticipate retiring in about 10 years. —Scott Bottorf, Johnston, Iowa

Answer: The decision to convert an IRA or 401(k) to a Roth IRA should be based on your overall finances today and your retirement prospects for the future (including an assessment of the tax hit you may face after retiring), not the level of the stock market at any given moment.

So, no, you shouldn’t convert to a Roth IRA just because stock prices have fallen.

Similarly, I don’t think it makes sense to try to time a conversion to coincide with a market decline. Granted, you’ll shell out less in tax if you manage to convert your IRA when its balance is lower rather than higher. But the way things have been going lately, it’s entirely possible that the market could fall farther from here, in which case you would have been better off waiting even longer to switch to a Roth. You can’t win this sort of guessing game.

That said, if you believe that converting some or all of your IRA to a Roth IRA does make financial sense you may want to consider converting before the end of the year.

Why? Well, you’ll be well-positioned to take advantage of a little-known “do over” provision in the Roth regulations that could help you lower your conversion tax bill if the market drops after you convert.

Oh, and if you’re in the unfortunate position of having converted to a Roth IRA earlier this year before the market fell apart – in which case your conversion tax bill may be higher than it would have been had you held off converting until after stock prices had fallen – you may be able to use the same “mulligan” rule to undo and then re-do your conversion and save yourself a bundle in taxes.

Do over

The technical term for it is a “recharacterization.” Basically, if you have converted money in a traditional IRA or 401(k) to a Roth IRA, a recharacterization allows you to undo the conversion and return the money (plus investment earnings, if any) to a traditional IRA. It’s as if the conversion never happened. The neat part is that you can then reconvert to a Roth IRA later on, if you wish.

Of course, as with anything related to taxes and retirement accounts, there are a few rules you’ve got to follow to get this second chance. You can recharacterize a conversion any time up to the income tax filing deadline with extensions for the tax year of the conversion. So if you convert in the 2008 tax year, you can recharacterize as late as October 15, 2009.

If you want to convert back to a Roth again, you must wait at least until the year after your original conversion (so 2009 or later if you converted in 2008) and  your re-conversion must be at least 31 days after the recharacterization. Finally, you must still meet the conversion eligibility rules when you reconvert.

So how can this “do over” work to your favor if you convert to a Roth IRA now?

Well, let’s say you’re in the 25% tax bracket and you’ve got an IRA that had a $150,000 balance at the beginning of the year that has since fallen to $100,000. You’ve also decided that a conversion makes financial sense for you. And although you can’t take credit for planning it this way, you like the fact that if you convert your IRA at today’s depressed stock prices, you’ll have to come up with $25,000 to pay the conversion tax bill instead of the $37,500 you would have had to fork over had you made the switch when your IRA was worth $150,000.

By doing the conversion before the end of the year, you also lock in the right to re-do the conversion in 2009. That can be nice option if the market continues to slide.

For example, let’s assume you convert between now and the end of the year and the market plummets again in early 2009, knocking down your Roth IRA balance to $80,000. You could recharacterize, move the $80,000 back to an IRA and then reconvert after waiting 31 days. (For that matter, if the market dives again this year, you could recharacterize this year and then reconvert anytime in 2009, assuming at least 31 days have passed since your recharcterization.) If your IRA balance is still $80,000 when you reconvert, you would pay $20,000 in tax instead of the $25,000 for your original conversion, a tidy $5,000 savings.

Of course, you do take the risk that the market could recover after you recharacterize, pushing your account balance back to its original value or higher before you can re-convert. Were that to happen, you could owe more in tax than you would have paid for your original conversion. But you can reduce that possibility by keeping the period between your recharacterization and reconversion as short as legally possible.

Which is why you might want to convert in 2008. If you hold off until next year, you would still have the right to recharacterize and undo your conversion in the event of a market decline. But since you can’t re-convert the same year of your original conversion, converting in 2009 would mean you would have to wait until 2010 to reconvert. That increases the chance that the market might rebound and that you could face a higher tax bill.

So if you believe you’re a good candidate for a Roth conversion and you would at least like to have the option of reconverting next year in the event the market continues to slide, you may want to get that conversion in before the end of the year.

Ah, but what if you’ve already converted to a Roth this year before the market fell apart? Well, you can also use the “mulligan” rule to undo your original conversion and possibly shave your tax bill. Just as in the example above, you would recharacterize, move the money back to a traditional IRA and then reconvert to a Roth in 2009 (and after waiting at least 31 days from the recharacterization). Assuming your traditional IRA’s balance hasn’t rebounded back to its level when you originally converted – and that you haven’t moved into a higher tax bracket – your tax bill will be smaller than it was with the original conversion.

Tax considerations

Clearly, taxes are a major factor in deciding whether to convert to a Roth (or re-convert, for that matter). The reason is that by converting to a Roth IRA, you pay income tax on the taxable portion of your traditional IRA today rather than postponing that hit until retirement. So, generally, it’s worthwhile to convert only if you expect the tax rate you’ll face in retirement will be the same or higher than your rate at the time of your conversion.

Taxes are always a bit of a wildcard. And now that a new president who made sweeping tax changes a major part of his campaign will be taking office in January, the tax picture is even more uncertain.

For example, while stumping for the presidency, candidate Obama said he would eliminate taxes for seniors making less than $50,000 a year. It’s anyone’s guess whether this provision will make its way into law and how it would actually work if it does. (Will all income qualify for the exemption or just earned income? How will income above $50,000 be taxed?) But if you’re nearing retirement, it raises at least the possibility that converting to a Roth IRA could be a bad deal since you would pay tax on traditional IRA dollars you might able to withdraw free of tax.

You certainly don’t want to be changing your retirement planning on the basis of every tax proposal that’s floated in DC. You would be in a state of perpetual motion, and have no coherent strategy. Besides, when it comes to the issue of tax-free Roth accounts vs. tax-deferred IRAs and 401(k)s, the very fact that tax policy can change so often suggests that it’s a good idea to have at least some money in a Roth account as well as traditional IRAs and 401(k)s to diversify your tax exposure in retirement.

But given the new administration and shift in the makeup of Congress, you definitely want to stay alert to possible changes in the tax laws that may affect your decision to convert.

And above all, remember: if you do convert but later think better of it, at least you’ll have a shot at reversing the decision.

Question: Are stable-value funds a safe investment? —Rexford, Syracuse, New York

Answer: That depends on what you mean by safe.

Stable-value funds, which are available only in 401(k)s (and currently offered by more than half of such plans), invest for the most part in high-grade short- to intermediate-term bonds. The managers of these funds also buy “wrappers” – or contracts from insurance companies and banks – that guarantee principal and accumulated interest against loss.

As a 2007 study shows, the result is an investment that provides long-term returns similar to those you would get with intermediate-term bonds, but with stability comparable to a money-market fund’s.

Would I put stable-value funds in the same category as FDIC-insured bank deposits when it comes to principal protection? No. They’re not federally insured. But given the high quality of the funds’ underlying securities and the fact that they also diversify risk by purchasing wrappers from 10 or so financial institutions on average, I think it’s fair to say that stable-value funds provide a high level of security and adequate protection against losses.

So in that sense I’d say yes, they’re a safe investment.

Playing it too safe

But when it comes to investing for retirement, I believe you should to take a broader view of safety. Specifically, you’ve got to consider whether your investments are safe in the sense that they’re likely to deliver the returns you’ll need to build a nest egg large enough to support you comfortably in retirement.

And that’s where I think people who’ve been flocking to stable-value funds lately – in September alone, 401(k) investors switched $921 million out of stock funds and moved $733 million into stable-value funds – have to be careful.

Understandably everyone is freaked out about declining balances of 401(k)s. Those losses and fears that even more may lie ahead make investments that promise security especially appealing today. But you don’t want to plow too much of your money into investments that offer a refuge from market losses.

There may be few concepts you feel you can count on in the investing world today. But here’s one you can bank on: The more secure an investment is, the lower its long-term returns are likely to be. So by focusing too intently on safety in the short-term, you could jeopardize your long-term retirement security by sacrificing growth potential.

Which is why I think you shouldn’t view stable-value funds as a haven to flee to during periods of market turmoil, but as a core part of a diversified portfolio that also includes stocks and bonds. Basically, you should consider stable-value funds an investment choice for the fixed-income portion of your 401(k), along with bond funds.

As for how much of your 401(k) you should put in stable-value and bond funds, the answer largely comes down to how far along you are in your career and how much risk you’re comfortable taking. I know everyone is wary about investing in stocks right now. But if you’re young and early in your career, you don’t have to be so concerned about falling stock prices. You’ve got decades before you’ll tap your 401(k), so you should focus on getting a competitive long-term return. And that means keeping most of your money in stocks.

Although there’s no assurance stock prices won’t fall even farther from here, history shows that you’re likely to earn the best long-term returns from shares you buy in the wake of major market declines.

As you get closer to retiring, you still need long-term growth – after all, you may spend 30 or more years in retirement – but you also want more stability. You don’t have as much time to recoup losses. So you want to gradually increase the amount going into stable-value funds and bonds as you age.

So if it’s safety you’re looking for, yes, stable-value funds can be a reasonable choice. But make sure they’re part of a long-term investing strategy. Otherwise, the price of feeling safe today could be less retirement security down the road.

Question: In the midst of the turmoil on Wall Street, I’m thinking of investing in gold, specifically bullion or gold coins. Do you think this is a good idea? —Roderick Gaerlan, Redondo Beach, Calif.

Answer: Ever since the financial markets began going haywire this year, I’ve been getting lots of emails from people who are considering buying gold as a way to weather the crisis.

That, I can understand. Investors have come to see gold as a refuge in a sea of uncertainty and volatility, an investment that will hold its value even as the world collapses around it.

What I can’t fathom, though, is how gold acquired and manages to maintain this reputation as an anchor of stability. It doesn’t make sense.

I mean, just look at a chart that tracks the price of gold so far this year. It started out at about $850 an ounce in January. As oil and gas prices started to climb and pundits began predicting that oil might hit $200 a barrel, gold quickly shot up, spiking as high as $1,011 an ounce in March.

After breaking the thousand-buck barrier, however, gold retreated and began bouncing around in a trading range of $850 to $950 in the spring and early summer. It flirted with its previous high briefly in July, hitting $986 an ounce, but then dipped back below $750 in September. It rallied again to break $900 an ounce in early October, but has since dropped below $800, closing out October at $731 an ounce.

So let’s see, that’s a 19% gain from the beginning of the year to its March peak, then a 26% drop from March to the September low, a 20% rebound to early October and then another 19% decline to the end of the month, putting gold 14% below where it began the year and 28% below its March high.

The point isn’t so much that as of the end of October gold was in the red for the year to date. It’s that if you’re looking to avoid gut-wrenching ups and downs, this isn’t much of an improvement from the stock market. It’s kind of like getting off Six Flags’ Kinga Ka rollercoaster and jumping on Coney Island’s Cyclone. The drops may not be quite as steep, but you’re still in for a white-knuckle ride.

That’s not to say that you can’t make money in gold. You can if you’re able to get in and get out at the right time (although, human nature being what it is, most people are eager to buy when gold is in the news and prices have already jumped, not when it’s unpopular and its price is languishing).

And since gold prices are not highly correlated with stock prices, you can also make a case for investing a small amount of your assets (maybe 5% to 10%) in gold as a way to diversify your portfolio.

I’m not a big advocate of this approach, but if you’re going to do it, I’d say precious metals mutual funds or a gold ETF is a simpler, cleaner and better way to go than buying coins or bullion. (I’d also add that you have to be willing to rebalance your portfolio periodically for this strategy to work.)

I don’t think it’s ever a good idea to move all of your investment stash into any safe haven or, in the case of gold, putative one. As I’ve noted before, the money you’re investing for longer-term goals like retirement should be invested in a blend of stocks and bonds that’s appropriate given your risk tolerance and how long it is until you’ll need the money.

That said, virtually all of us also need to keep some portion of our assets protected from the ups and downs of the financial markets. Here, I’m talking about an emergency fund or, in the case of retirees, an account that holds 12 to 18 months’ worth of living expenses.

But the right place for this segment of your portfolio is a totally liquid and secure investment such as a high-quality money market fund, short-term CDs or savings account, not gold. For, whatever other qualities it may have to offer, stability of principal is not one you can count on from gold.

No one knows when we’ll reach a bottom, but you can get a great bargain, if you shop around.

Questions: Given all the foreclosures and other problems in the housing market and the economy, do you think this is a good time for someone to buy a house? Or would I be better off waiting for the housing market to recover? —Mari, San Francisco

Answers: If you’re asking me to predict when the housing market will hit bottom and when prices are likely to start climbing again, I’m sorry, but I can’t help you. My housing crystal ball is on the blink.

I can tell you, though, that at this point we’re still looking at one bleak house scenario.

If anything, the latest price statistics suggest that the market is still falling. The Standard & Poor’s/Case-Shiller Home Price Index for 20 large metropolitan areas was down 16.6% in August compared to its level a year ago. That’s more than the index was down for the year ending in July (16.3%) and in June (15.9%). National Association of Realtor stats for September also show a decline.

On a marginally positive note, there has been somewhat of an uptick in sales of both existing and new homes. But given the fact that foreclosures and mortgage delinquencies have also been rising and the job market and the economy generally have been softening, I don’t think anybody believes that the recent improvement in sales represents an imminent reversal of fortune.

I suppose it’s possible that the various government and private efforts to help homeowners avert foreclosure could help stabilize the market. When you look at the overall picture, however, it’s hard to imagine the housing situation improving significantly before the end of next year.

Don’t time the market

But I don’t think all this necessarily means that you should put off buying until certain prices have bottomed out, assuming you’re planning to live in your house for, say, at least five years as opposed to flipping it.

Why? Well, for one thing I don’t think it’s possible to time the housing market any more than it is to time the stock market. Sure, you might be able to get a somewhat better deal by postponing your purchase. On the other hand, it’s unrealistic to think that you’re going to be able to catch the market just as prices are ready to rebound.

Buying a house isn’t something you can do at a moment’s notice. You’ve got to find the house you really want, settle on a price and get your financing. Your chances of timing all this to coincide with the market trough – even if you could call it – are pretty much nil. Besides, even when prices do eventually start to rise, no one knows how quickly (or slowly) they’ll climb.

Do some legwork

That said, if you’re really serious about owning a home, you’re actually in a very good position as a buyer right now. Prices have fallen substantially over the past year or so, which should give you lots of leverage to negotiate a favorable price. And since there’s no immediate sign of a turnaround in the market, it’s not as if you’ve got to rush into a deal either.

So don’t. Use this opportunity to do plenty of research in areas where you might consider buying. You can do that online these days at sites like Zillow and Trulia.

But don’t restrict yourself to virtual legwork. Drive around a bunch of neighborhoods, talk to homeowners and business owners to get a better sense of how the area is doing and what it would be like to live there, stop by real estate offices and banks to get the current pulse of that specific market. You may even be able to pick up bargains among foreclosures or by working with sellers eager to avoid a foreclosure.

At the same time, you can start lining up your financing so you’ll be ready to move ahead should you find a home you like at a price you’re willing to pay. Remember, lenders are more picky about making loans than they were during the real estate bubble, which means they’re requiring more information about your income, assets and expenses.

You don’t want a snag in the mortgage process to hold you up when you’re ready to close a deal. So get all your financial paperwork in order ahead of time and scout out lenders offering competitive loan rates, which you can do by checking out our Real Estate section.

Bottom line: Without the benefit of 20/20 hindsight, no one can tell you when it’s the absolute best time to buy. But if you make a real effort to shop around and get a feel for the market, you can almost certainly increase your chances of getting a house at a price you can be happy with now and in the future.

Question: I have a loss on stocks in my IRA account. Can I sell those stocks and then use the loss to offset gains outside my IRA?  —Michael L., The Woodlands, Texas

Answer: Earlier this week, I wrote a column explaining how investors may be able to capitalize at least a little bit on the current market slump by harvesting investment losses in taxable accounts and trimming their tax bill in the process.

But given the battering retirement accounts have taken lately – the Boston College Center for Retirement Research estimates that the value of stocks held in IRAs and 401(k)s has declined by $2 trillion for the 12 months through October 9th – I’m sure there are plenty of people wondering whether they might be able to deduct losses in such accounts.

Alas, the short answer is probably no. It’s a lot harder to take a tax loss in IRAs and the like than it is in a taxable account.

That said, there are limited circumstances under which you might be able to take a deductible loss in a tax-advantaged retirement account. Even if you can, however, it’s questionable whether it’s a good idea.

Let me start by explaining why it’s unlikely you would be able to turn losses on investments held in IRAs, 401(k)s and the like to your tax advantage in the first place.

Establish a basis

Let’s say you contributed $5,000 to a traditional deductible IRA at the beginning of this year and bought 500 shares of a stock trading at $10 a share. And let’s assume the price of that stock has since sunk to $5 a share, leaving you with a $2,500 loss.

You might figure that you should be able to apply that loss against gains outside your IRA or otherwise deduct it, as you could with a loss in a taxable account.

But tax rules don’t allow for a tax break in this case, which makes perfect sense when you think about it.

After all, when you made the contribution to your IRA, you got a tax deduction that reduced your tax bill. If you also get to deduct a loss on an investment made with that money, you would be getting two tax breaks on the same dollars. Uncle Sam is generous with retirement accounts, but not that generous.

Which brings us to the heart of the matter about losses in retirement accounts: To have a shot at deducting them, you must have money in your account on which taxes have already been paid. That gives you what is referred to in tax circles as “basis,” which is essentially the value of after-tax dollars you have tied up in an investment.

In the case of a traditional IRA and 401(k), you would have basis only if you made nondeductible or after-tax contributions. All your contributions to Roth accounts, on the other hand, qualify as basis since you can contribute only after-tax dollars to Roth accounts.

Cash in

But even if you have basis in an IRA, you can book a tax loss only if you cash in your IRA and its liquidation value is less than the amount of after-tax contributions in your account. You can’t take the loss without closing the IRA.

In fact, the rules are more stringent than that. If you own more than one traditional IRA, you would have to liquidate all your traditional IRAs to establish a loss. The same goes for Roth IRAs. If you wanted to book a loss on your Roth IRA, you would have to liquidate all Roth IRAs, if you have more than one. You can’t cherry pick only IRA accounts where you have a loss.

The rules for losses in 401(k) accounts aren’t spelled out as definitively, but the consensus of the tax gurus I talked to about the issue is that the same principles apply to 401(k)s, with one difference: if you have several 401(k)s, you wouldn’t have to liquidate them all to take a loss in one of them. (Of course, if you have a loss in a 401(k) with your current employer and you’re not switching jobs or retiring, cashing out isn’t an option anyway.)

Establish a loss

But let’s be real here. It’s unlikely many people would be able to establish a loss for tax purposes in a traditional IRA or a 401(k). That’s because balances in these accounts usually consist of dollars that have yet to be taxed – deductible or pre-tax contributions and untaxed investment earnings.

Even if you have after-tax dollars in such an account that would give you the tax basis you need to establish a loss, the loss would have to be so large that it wipes out all your deductible or pre-tax contributions as well as all the earnings in the account. Only after that would you be in tax-loss territory. That’s a big hurdle, especially if it’s an account you’ve been contributing to for several years.

The bar is lower for Roth accounts. Since you’re contributing after-tax dollars, only the earnings in a Roth account stand between you and a tax loss. Given the magnitude of recent stock losses, it’s quite possible that anyone who opened a Roth over the past year or so could be sitting on a deductible loss.

Itemize deductions

But even if you have a loss in a tax-advantaged retirement account, turning it into a worthwhile tax benefit is another matter.

When you have a capital loss in a taxable account, you simply use it to erase a realized capital gain you have from another investment or, in some cases, apply at least some of the loss against wages or other income.

But losses in IRAs and similar accounts must be taken as a miscellaneous itemized deduction. That means you can take the deduction only if you itemize, as opposed to taking the standard deduction when you file your taxes. You can deduct only the portion of your miscellaneous deductions that exceeds 2% of your adjusted gross income. Even then, you could lose some or all of the benefit of the deduction if you end up being subject to the dreaded AMT, or alternative minimum tax.

Weigh your options

Finally, I doubt that it would make sense to take the loss in a tax-advantaged account even if you did manage to qualify for it.

Why? Well, you may get a tax break with the deduction, but by cashing out your account you’ll also be giving up tax-deferred growth on your money, or tax-free growth in the case of a Roth.

If you really want to recoup your losses and even increase the value of your account, your chances of doing that are better by keeping your money in a tax-advantaged account where it can grow without the drag of taxes.

Bottom line: If it’s investment tax losses you’re after, you’re probably better off turning your attention to securities you own in taxable accounts.

But if you’re looking to safeguard your retirement in today’s tumultuous market, I think your time would be better spent reviewing your overall retirement-planning strategy.

Question: I’m 66 and have major stock losses in my investment accounts. Can I use those losses to reduce what I’ll owe in income taxes? —Ben G., Roanoke, Texas

Answer: Unless the stock market does an abrupt about-face and claws its way back into positive territory in the next two months, a lot of people like Bennie here are going to be sitting on some pretty nasty losses for the year.

Well, there’s little you can personally do to change the market’s direction. Even big shots like Treasury Secretary Hank “Bazooka” Paulson and Federal Reserve Chairman Ben “Helicopter” Bernanke haven’t been able to manage that.

But you may be able to take a bit of the pain out of falling stock prices by harvesting some investment losses in your taxable accounts and trimming your tax bill in the process. If you want those losses to trim your taxes for 2008, however, you’ve got to take them by the end of the year.

The process of booking tax losses is fairly straightforward, but, as is usually the case with taxes, there are a couple of little twists you need to be aware of. Here’s the drill.

Offsetting gains. If you own shares of stock or mutual funds that are now trading for less than you paid for them, you can sell those shares to establish a loss. You would then use this loss to offset any realized capital gains that you have on stock or fund shares, in effect erasing the tax you would otherwise owe on those gains.

Gains? What gains? I can imagine you saying. Well, the gains could be shares of stocks or funds you sold for a profit earlier this year before the market really plummeted or, for that matter, shares that you bought long enough ago so that you were still able to unload them for more than you paid despite the market’s dive.

If you own funds, remember: even if the fund posts a loss for the year, it could still have net realized capital gains from securities it sold for a profit at some point during the year. Since funds are required by law to distribute net realized capital gains to shareholders each year, you could end up with a taxable capital gain even if your fund has a loss – and even if you haven’t sold shares.

If your fund distributes short-term capital gains, those gains are considered ordinary income for tax purposes. You wouldn’t offset a fund’s short-term capital against your capital losses.

But if your fund distributes long-term capital gains, you would apply capital losses from other securities against the fund’s long-term capital-gains distributions just as you would against capital gains stemming from sales of stock or fund shares.

Deducting a loss. If the loss you have from selling stock or fund shares exceeds the amount of capital gains you have – or if you don’t have any capital gains at all – you can apply up to $3,000 of your capital loss against ordinary income. That would include wages, interest from CDs and the like, dividends and even taxable Social Security benefits and pension income, including taxable withdrawals from IRAs and 401(k)s.

If you still have losses left over after doing this, you can carry them forward to later years.

Short-term vs. long-term losses. I’ve simplified this process a bit. Actually, the tax code requires that you pair short-term losses with short-term gains (that is, gains or losses on securities you’ve held a year or less) and long-term losses with long-term gains (gains or losses you have on securities you’ve held more than a year) in order to arrive at a net capital gain or loss. For details on how to do that, you can check out IRS Publication 550.

No double dipping. While you’re perusing this fascinating publication, you’ll also want to check out the section on wash-sale rules to assure you don’t violate them. Basically, if you buy the same security or a “substantially identical” one 30 days before or after the sale you made to establish a loss, the IRS will disallow all or part of that loss. So be careful. You don’t want to go to the trouble of taking a loss only to screw up the deduction.

Stock swap. Ah, but what if you would like to take a tax loss but you still think the fund or stock has good potential? Or what if you would like to take advantage of the market slump, but you don’t want the screw up the mix of assets in your portfolio?

In that case, you can do a tax swap: sell a stock or fund and quickly replace it with one that’s similar. Just make sure you don’t immediately buy the same stock or fund or even one that’s “substantially identical” – say, replacing Vanguard’s S&P 500 index fund with Fidelity’s S&P 500 index fund – lest you run afoul of the wash-sale rules.

But you’ve still got plenty of maneuvering room around this restriction. If you sell shares of, say, an S&P 500 index fund, you could always buy shares of a total stock market index fund. Or if you’re selling an actively managed fund, check out the fund’s category, investing strategy and risk-return profile at Morningstar.com and then look for a fund in the same category with a similar strategy and profile.

It’s harder to find a close match with stocks, but you can likely find a decent fit by looking for a company of roughly the same size in the same industry, or you can buy a sector fund or ETF that tracks the same industry. Once you’re beyond the 30-day wash-sale threshold, you can then buy back shares of your original stock or fund, if you wish.

So between now and the end of the year, take a look at your portfolio to see if you might be able to turn some losses to your tax advantage. Granted, a tax write-off isn’t as nice as a gain. But these days, you take what you can get.

A market dip in the years before retirement can be scary, but bailing out of stocks isn’t the answer. Here’s how to make sure you’re still on track.

Question: I am 61 and plan to retire in about eight months. Given the current market, do you think I should withdraw some or all of my 401(k) money and put it in a safe place that is covered by FDIC insurance? This is part of my retirement income. —Peggy Wagstaff, Marietta, Georgia

Answer: There’s no doubt that the older you are and the closer you are to retirement, the more frightening the current economic crisis is. After all, if you’re ready to retire or have already called it a career, you simply don’t have as much time to wait for stock prices – and your 401(k) account balance – to rebound.

If you’re drawing money from your retirement portfolio for income and your investments are dropping in value, the double-whammy of withdrawals and losses leaves you with less capital to participate in the market’s recovery, increasing the chances that you may run out of money later in retirement.

But moving your 401(k) stash and other retirement savings into safe options like CDs, a stable value fund or a money-market fund isn’t the right response.

What you really need to do is give yourself a more comprehensive retirement check-up that looks not just at your 401(k) investments but also helps you figure out what other moves you may need to make to assure a secure retirement down the road.

Here are three steps you can take to make that broader assessment.

Coolly review your investment strategy

Hunkering down in the security of conservative investments may be emotionally appealing. But unless you’ve got a huge nest egg, the yields you’ll earn on such options are just too low to provide adequate income and maintain your purchasing power in the face of inflation over a retirement that could easily last 30 or more years.

So while the stock market may be the last place you want to put any of your retirement money right now, the fact is that you still need the long-term growth that equities have historically provided. The key is to get that growth without being pummeled too badly during market downturns.

One reason so many pre-retirees are hurting so badly now is that they went into this crisis with far too much of their retirement savings in stocks. In recent testimony [www.ebri.org] before Congress, Employee Benefit Research Institute research director Jack Vanderhei noted that nearly four out of 10  401(k) participants in their mid-50s to mid-60s had 80% or more of their account invested in stocks in 2006.

Hey, I’m an optimist when it comes to the long-term outlook for stocks. But unless you’re holding a big cache of cash or bonds in some other account, having 80% or more of your 401(k) in equities is just way too aggressive for someone already retired or nearing retirement.

Reasonable people can disagree about what the exact blend of stocks and bonds should be, but for anyone on the verge of retiring or already in the early stages of retirement, something in the neighborhood of 55% stocks and 45% bonds is more appropriate. As you age, you should cut back your stock holdings even more, until you’re down to 20% to 30% in equities by the time you’re in your 80s.

Determine whether your planned retirement date still makes sense

The key question you must answer here: Given your 401(k)’s current value, can you still draw enough from your account to live comfortably over the next 30 or more years without running out of money before you run out of time?

The only real way to know is to crunch the numbers. You must figure out how much income you’ll need to live comfortably in retirement and then see if you can realistically expect to generate that amount from Social Security, any pensions you may have plus what you can safely draw from your 401(k) and other retirement accounts.

Any decent financial planner should be able to help you with this sort of analysis. You can also do it on your own by going to an online tool like the Retirement Income Calculator in the Investment Guidance and Tools section of T. Rowe Price’s site.

Originally designed for people who were already in retirement, this tool has been re-tooled, so to speak, so that you can also use it if you’re still in the pre-retirement stage.

Plot a course of action

If you’ll have enough coming in to cover your living expenses, great. You can stick to your scheduled retirement date.

But if you’re coming up short – and I suspect many people will, given the toll the market’s decline has taken on retirement  accounts – then you’ll have to make some changes.

One option might be to retire on schedule but work part-time in retirement. Or you might decide to work a couple of more years. That would not only allow you to accumulate a couple extra years of saving, it would also give your portfolio a chance to recover.

And there’s another advantage to working a few more years: a bigger Social Security check. Each year you delay taking benefits beyond age 62, you get “delayed retirement credits” that can boost your monthly check by about 8% for each year you postpone up to age 70. Your Social Security check might go up even more because the extra accumulated wages can increase your benefit. You can see how much more you might receive by working a few extra years by going to Social Security’s new Retirement Estimator .

It’s crucial that you give yourself this sort of pre-retirement check-up before you leave a job that’s providing a good paycheck and decent health benefits. Otherwise, you may find yourself having to go back into the workforce where, as an older worker, you may have a hard time duplicating the pay and benefits package of your old employer.

Finally, whenever you eventually decide to retire, be sure to check in every year or two with a planner or calculator to assure that you’re not going through your retirement savings too quickly.

Starting with a modest initial withdrawal of around 4% of your retirement portfolio’s balance and then increasing that amount for inflation each year generally gives you about a 90% chance that your savings will last at least 30 years. But if your 401(k)’s value takes a big hit early in retirement and you don’t adjust your withdrawals, those odds can plummet.

So if you retire into a slumping market like this one, you may want to cut back your spending a bit so that your savings well doesn’t run dry late in retirement. After all, what could be more disconcerting than to realize that you’re in good enough shape to go another 10 or 20 years in retirement but your portfolio’s only healthy enough to make it another five?

iReport.com: What’s your dream retirement?

Question: Does the current crisis have any effect on my defined-benefit pension plan?  I just turned 55 and was getting ready to start drawing from it. Will the amount I receive change now? —Lynn, Hephzibah, Georgia

Answer: The short answer is no. Just because the stock market has been reeling and the economy is in a major funk, your employer can’t reduce the size of the pension you’ve earned or take it away from you.

If nothing else, the current financial crisis has highlighted a major difference between traditional check-a-month defined-benefit pensions and defined-contribution plans like 401(k)s.

With a 401(k), a market meltdown can dramatically reduce your account balance. And if that happens after you’ve retired or are close to doing so, you may have to cut back on the income you draw from your 401(k) to avoid running out of money late in retirement.

With a traditional defined-benefit pension, on the other hand, the amount you receive is based on the number of years you worked for your company and your salary (typically the average for your last five years or your highest-earning five years). Once you’re “vested” in your plan – which usually takes five years in a traditional defined benefit plan – your employer is obligated by law to pay you the pension you’ve earned, regardless of how the financial markets perform (although you’ll typically have to wait until you’re 55 to 65 to collect it).

In short, if you have a 401(k), you assume the market risk. If you have a defined-benefit pension, your employer is on the hook.

The risks

Of course, plummeting stock prices have put a strain on the value of pension fund assets, and those assets are what employers are counting on to pay the pensions of current and future retirees. Generally, pension funds invest about 65% of their assets in stock and spread the rest among bonds, real estate and other investments. So when the stock market takes a dive, it cuts into the amount available to pay pension benefits.

That said, pension funds overall went into this year in pretty good shape. According to benefits consulting firm Hewitt Associates’ Pension Risk Tracker, the overall “funded ratio” of the pensions of companies in the Standard & Poor’s 500 index was 98% at the beginning of the year, which means the value of the assets in the funds was just about sufficient to cover the benefits due to plan participants. By mid-October, however, falling stock prices had pushed that ratio down to just over 80%.

The safety nets

But that doesn’t mean pension funds won’t be able to meet their commitments. Pension funds pay out their benefits over many decades. Indeed, a 35-year-old worker may not begin collecting for another 20 to 30 years and even then the payments will likely stretch over another 20 to 30 years. So there’s plenty of time for asset values to bounce back.

What’s more, the Pension Protection Act of 2006 set tough new standards for how much money employers must contribute to their pensions annually to maintain their plan’s financial health. (The PPA doesn’t apply to defined-benefit plans of state and local governments, but those benefits are protected by state law and ultimately backed by tax revenues.)

Besides, even if your company were to go bankrupt and the pension plan’s assets were insufficient to meet its obligations, you would still likely collect all or most of the pension you have coming to you. That’s because the Pension Benefit Guaranty Corp., a government agency charged with assuring the payment of private-sector pensions, would step in and make payments up to certain limits.

The PBGC’s maximum payment for plans ended in 2008 is $4,312.50 a month, or $51,750 a year, for a 65-year-old. This ceiling is higher if you’re older and it’s lower if you retire earlier or if your pension includes payments for a survivor.

There are instances when the maximum payments aren’t enough to cover someone’s full pension, as has been the case with many pilots of airlines that went bankrupt. But more than 80% of the people whose pensions are taken over by the PBGC see no reduction in payments.

There’s one other way that the current crisis could affect defined-benefit pensions, however. If pension funds’ investment losses are deep enough, employers could be required to inject big sums of cash into their plans at the very time when their profits are being squeezed by the weak economy. If that happens, more companies might follow the example of companies like IBM, Unisys, Gannett, Equifax and others that have already frozen their pensions or announced plans to do so.

In the event of a freeze, you would typically no longer accrue additional benefits in the frozen plan for additional years on the job, although companies that freeze plans may enhance benefits other ways, such as by adding a 401(k) or improving the 401(k) if the firm already offers one. In any case, you would still be eligible for whatever benefits you had accrued before the freeze. Any pension benefit you’ve earned can’t be taken away. (If you think you have been unfairly denied pension benefits, check out your rights.)

So unless your pension plan is seriously underfunded and your company is in financial trouble and your pension is significantly above the PBGC ceiling, you can cross your defined-benefit pension off your list of things to worry about. And then turn your attention to your 401(k) and other retirement savings accounts to be sure you’re following the right investment strategy there.

Question: If an investment firm like Fidelity or T. Rowe Price goes bust would I lose the money I have in mutual funds in IRAs and other accounts? —Gerry Cheok, Gaithersburg, Maryland

Answer: Already in this financial crisis, we’ve seen investment banks, commercial banks and mortgage firms fail or require some sort of government bailout to keep them afloat.

To date, however, no mutual fund companies have bitten the dust or required a government loan or investment to prevent them from going under. I hope that will continue to be the case, although in this wild and wooly market, I suppose anything is possible.

But the good news is that even if a fund family were to get in trouble or go belly up, the money you have invested in mutual funds – whether in an IRA, 401(k) or any other type of account for that matter – would still be safe.

Indeed, the value of your mutual fund accounts is pretty much unrelated to the health of the fund company itself.

Why? Several reasons.

Separation of assets

First, the money you invest in a mutual fund doesn’t actually become part of the assets of the mutual fund firm, as is the case when you buy a CD at a bank. Instead, your money goes to whichever mutual fund you’re buying. You receive shares in the fund for your investment, and the fund manager then invests your money in securities that become part of that fund’s portfolio of assets.

And although most people think that the mutual fund firm – be it Fidelity, T. Rowe Price or any other fund sponsor – owns the mutual funds with the firm’s name on them, that’s not the case.

The fund firm – or sponsor as it’s known in fund industry lingo – merely has an agreement with the fund to manage its assets and sell the fund’s shares. The fund itself is a separate entity from the sponsor and has its own board of directors. And the owners of the fund are the fund’s shareholders, the people like you who have invested money in the fund own its shares.

That goes for all the securities in the fund as well – stocks, bonds, Treasury bills, whatever. The mutual fund firm doesn’t own them either. The fund’s shareholders own them. So if a mutual fund company were to get into financial trouble or go into bankruptcy, the assets of the individual funds would not be available to the mutual fund company or its creditors to meet the firm’s obligations.

No funny stuff

But, ah, you may ask, in dire circumstances wouldn’t the mutual fund company somehow manage to dip into the till even if only temporarily to get them out of a financial bind? Couldn’t fund shareholders’ money be at risk that way?

Actually, the odds of a struggling fund company getting its hands on fund assets are remote at best. To avoid such malfeasance, federal law requires that the securities owned by a mutual fund be held separate from the fund’s sponsor in a custodial account, usually at a bank or trust company. The fund’s assets are also segregated from the custodian bank’s or trust company’s assets as well.

Finally, to protect shareholders from the possibility that a dishonest employee of the mutual fund company, custodian bank or some other person could get at a fund’s assets, federal law requires funds have fidelity bond insurance which covers instances of fraud, embezzlement and the like.

I’ve sketched the main outlines of how mutual funds operate. But if it would make you feel better, you can get more detail by checking out this investment company fact book.

Should you be worried?

If your mutual fund company were to fail, the assets of your fund would be secure, totally insulated from the fund sponsor’s financial problems. The failing mutual fund company would arrange for another mutual fund company to assume management of your fund, or your fund’s board of directors would do so. Either way, you and other fund shareholders – who are still the fund’s owners – would have to approve the new arrangement.

Of course, these protections have nothing to do with the market value of the funds you own in IRAs or other accounts. That will be determined by the market price of the securities owned by your fund. If your IRA is invested in shares of a mutual fund that tracks the overall stock market and the stock market drops, so will the value of your IRA. But that has nothing to do with the financial health of your fund company.

To sum up, there are plenty of legitimate reasons to be concerned about our economy and the markets right now. But worrying that your retirement security might be jeopardized should your fund company fail isn’t one of them.

Question: I am currently contributing 15% of my salary to my 401(k). With the current crisis taking a toll on the stock market, would it be a good idea to reduce my contribution to 10% and place the additional 5% somewhere else? —Verona, Savannah, Georgia

Answer: Without a doubt, the last few weeks have ranked as the most tumultuous – and scariest – times that I’ve experienced in the more than 20 years I’ve been at Money magazine.

We’ve witnessed events that up to now had been almost unimaginable with the stock market fluctuating wildly up and down and governments around the globe taking stakes in or seizing control of major financial institutions in an attempt to unlock frozen credit markets. Yet, despite the extraordinary steps that have been taken, the questions of when we’ll hit bottom and how long a recovery will take still linger.

Given all this turmoil and uncertainty in the present, I can understand why you might be tempted to scale back a saving and investing plan that doesn’t have its payoff until sometime way off in the future.

But reducing your 401(k) contributions now would be a mistake for several reasons.

Keeping Uncle Sam at bay

To begin with, you would be giving up some lucrative tax benefits. You pay no income tax on the money you contribute to your 401(k), nor on the investment gains your contributions generate, until you begin making withdrawals in retirement.

That tax deferral is a huge advantage, which means you’re much more likely to end up with a larger nest egg by contributing to your 401(k) than by saving in a taxable account.

So foregoing those tax breaks alone – even on a portion of your savings – means you will almost certainly reduce the amount of money you’ll have available to you when you retire.

Building a bigger nest egg

Depending on your company’s policy on matching contributions, you may also be turning away the equivalent of free money if you shift funds outside your 401(k).

For example, if your employer kicks in 50 cents for each dollar you sock away, you’re effectively giving up an instant 50% return on your contribution. That’s a terrific deal at any time, but especially attractive today when losses have been the norm.

And let’s be honest, you’ve also got to ask yourself whether you’ll actually end up saving this 5% of salary you’re planning to divert from your 401(k). Without the convenience of a 401(k)’s automatic payroll deductions, good intentions to save can too often succumb to the temptation to spend. That’s an important consideration because when this crisis passes and the economy and markets recover – which they eventually will – you will still be counting on the balance in your 401(k) to finance a big part of your retirement.

Indeed, the additional debt that the U.S. government is taking on to deal with today’s financial crisis will place even greater strains on the federal budget in coming years, increasing the possibility of cutbacks in already stressed programs like Social Security and Medicare. Which means that more than ever before your security in retirement will likely depend on how successful you are in growing the size of your 401(k).

Saving for a rainy day

So while you’ll certainly want to make sure you’re investing your 401(k) money appropriately given current conditions now is not the time to cut back on your contributions.

With one possible exception.

We’ve already seen the unemployment rate climb from less than 5% earlier this year to just over 6% as of September. If economic conditions continue to deteriorate, companies may be forced to pare payrolls to cut costs, and the ranks of the unemployed could swell even more. So it’s especially important now that you have an emergency cushion of three to six months’ living expenses that you can tap should you lose your job.

This reserve should be tucked away in one or more highly secure stashes, such as federally insured bank accounts and short-term CDs or money-market funds run by large well-known fund companies.  (For an extra measure of safety, you can stick to money funds that participate in the Treasury Department’s money fund guarantee program.

If you don’t have such a cushion, you need to start building one pronto. Ideally, you would want to do this by tightening spending rather than contributing less to your 401(k). But if that’s not possible, you may have to resort to temporarily putting away less in your 401(k) or other retirement accounts.

I can’t stress enough, however, that such a move, if needed at all, should be temporary. Once you’ve created your emergency fund, be sure to bump your 401(k) contributions back to where they were before, if not a bit higher to make up for lost ground. To assure that the amount you’re setting aside will allow you to retire comfortably, you can check out our Retirement Planner.

That exception aside, don’t let anxiety about today’s financial crisis interfere with funding your 401(k). Otherwise, you may end up facing your own personal financial crisis when you’re ready to retire.

Question: I have $100,000 in an annuity with AIG that my mom and I depend on for income to live. Should I cash it out even though I would suffer a loss, or do you think I should hold onto it? It’s so hard to know what to do. —Kitty Schwartz, Plano, Texas

Answer: Most people buy an annuity at least in part because they see it as a refuge, an investment they can count even if the financial markets are spiraling downward. But that faith has been tested in recent weeks.

The government needed to step in to cover the debts of AIG, the nation’s largest insurer, and the health of many other major insurers has been called into question.

So it’s no surprise that I have been inundated with questions from people worried about the security of money they have in annuities.

I would love to be able to give a simple reassurance.

But annuities are often complicated products. I’ll try to lay out the most important issues surrounding that choice as best I can.

To do that, however, you first must understand the safety mechanisms that are in place for annuities so you can better gauge the risk you actually face (which for many people will be a lot less than they fear). And you must also understand the possible consequences of withdrawing your money from an annuity.

3 lines of defense

Basically, there are three lines of defense that protect the money you have in an annuity.

The first is oversight. Insurance companies are regulated at the state level, and the main job of each state’s insurance commissioner is to assure that the companies headquartered in that state have enough reserves, or capital, to meet their obligations to annuity owners and other policy holders.

The second line of defense becomes a factor when insurers run into trouble despite the oversight. Specifically, the state insurance commissioner steps in, do anything from arranging for a takeover of the ailing insurer to transferring annuities and other policies to a healthy insurer.

The third line of defense is the network of state guaranty funds, a factor if a failed insurer doesn’t have enough in assets to cover obligations annuity holders. Most states cover up to $300,000 for life insurance death benefits, $100,000 in cash surrender values for life insurance and $100,000 in withdrawal and cash value for annuities, although some states have higher limits.

This coverage is per person per insurance company. So if the state limit for annuities is $100,000 and you have a $100,000 annuity with one insurer and another $100,000 with a different insurer, you would receive $100,000 of coverage for each annuity.

A quick note about variable annuities. Most people who own variable annuities have their money invested in one or more “subaccounts,” or mutual fund-like stock or bond funds. The money in these subaccounts is segregated from the insurer’s assets and cannot be tapped by the insurer or its creditors. So while the market value of your variable annuity may decline, the money you’ve invested in a variable annuity would be safe should the insurer fail. (If you have invested in the variable annuity’s “fixed” account, that money is part of the insurer’s assets and would be covered by the guaranty fund.)

So if your annuity’s value is within your state guaranty fund’s coverage limit, you don’t need to bail out to protect yourself from a loss. That’s not to say you might not want to get out at some point in the future for peace of mind or if you decide annuities aren’t for you. But you don’t have to exit in a rush, which might trigger taxes and penalties. Your money is secure.

What if the value of your annuity exceeds these limits? In that case, you’ve got a few factors to consider.

Consider your insurer’s financial strength

Assessing the financial strength of your insurer is difficult if you’re not an insurance analyst. But you can get a feel for it by checking how highly your insurer is rated by ratings companies like A.M. Best, Standard & Poor’s and Moody’s. (It’s important that you have the exact name of your insurer, as there may be multiple subsidiaries with similar-sounding names, each of which is rated separately. The name of the insurer that issued your annuity should be on your contract.)

Granted, these ratings are hardly foolproof. Rating agencies can get it wrong. And rapidly deteriorating markets can make what was a sound company weeks ago vulnerable today.

It’s hard to draw a dividing line between what rating represents an acceptable level of safety and what rating doesn’t. But I think it’s reasonable that someone relying on an annuity for security would want to see a rating of A or better. (The rating scales vary somewhat between companies, but A is usually the third highest rating, after AAA  and AA.).

Weigh the taxes and penalties

You’ve also got to consider withdrawal penalties. Most annuities carry surrender charges that typically start at 7% or so and decline gradually each year until they disappear after seven years. In some cases, however, surrender charges can run as high as 20% and last 20 years. If you pull money out early, you could take a sizeable hit.

There is a bit of a loophole here, though. Most insurers allow you to withdraw a small amount – usually 10% of your balance – free of surrender charges each year.

Taxes are another consideration. If you withdraw money from an annuity, you’ll owe tax at ordinary income tax rates on any gains (and on your original investment if your annuity is held within an IRA account funded with tax-deductible or pre-tax dollars.) If you’re under age 59 ½, you’ll pay an additional 10% early withdrawal tax.

There is a way around the tax hit. Instead of just pulling your money out of the annuity, you can do what’s called a 1035 exchange into another annuity. In fact, you can do a 1035 exchange and split your money among two or more insurers with good ratings to diversify your exposure. You’ll still be in an annuity, of course. So if your goal is to exit the annuity altogether, this tactic wouldn’t help. A 1035 exchange also doesn’t exempt you from any surrender charges that may apply. And, indeed, by moving to a new annuity, you would likely start the clock again on a new set of surrender fees, which could make a future exit more costly than getting out today.

Bottom line: If your annuity’s value is over your state’s guaranty fund limit, you’ve essentially got to weigh the cost of getting out vs. the risk of staying in.

If you have an annuity with a highly rated insurer and the surrender charges are still quite high, you might prefer to just hold on at least for now, especially if your annuity’s value isn’t that far above the guaranty fund’s limit. You can always pull money out later on or move it to another insurer via a 1035 exchange after the surrender charge has fallen.

You could even reduce your exposure above the guaranty limit gradually by taking advantage of the annual surrender-free withdrawal provision.

If, on the other hand, the insurer has a low rating or you’re really worried about a loss and the surrender penalty isn’t too severe, you might want to switch via a 1035 exchange to an annuity with a highly-rated insurer, especially if the annuity’s value is well above the guaranty coverage.

If the insurer’s rating is low and the surrender penalty is still high, you could also consider doing a partial 1035 exchange – that is, move enough of your current annuity to an annuity with one or more highly rated insurers so that each annuity falls within or at least not too far above your state’s guaranty fund limits. You would still have to pay a surrender charge, but at least it would be on only a portion of your annuity’s value.

All this comes down to a personal judgment. But I think that ultimately, if you’re going to own annuities, you want to have your money spread among two or more insurers and, to the extent possible, below the guaranty fund limit for your state. You don’t have to get to this position overnight. But the weaker your current insurer is and the higher above the guaranty limits you are, then it seems to me the sooner you want to do this.

Are annuities for you?

One final note: I think this is a good time for people who own an annuity – or are considering buying one – to ask themselves whether they really ought to be in an annuity at all. I’ve long recommended a particular type of annuity – an immediate annuity – as a way to convert a portion of your savings to a lifetime income once you’ve retired.

But immediate annuities represent a very small portion of annuity sales. Most of the annuities that are sold fall into two categories: fixed deferred annuities, which are sold to older investors, most of whom I think would likely be better off in bank CDs and bonds; and variable annuities, which are touted as mutual funds that can shelter their gains from taxes and often sold (usually inappropriately in my opinion) as investments for IRAs and 401(k) rollover money to people who are still years away from retirement.

If nothing else, I hope the attention that insurers and annuities are getting will lead investors to re-assess (ideally with the help of a financial adviser who doesn’t depend primarily on annuity sales for his or her livelihood) whether they really belong in annuities.

As I said at the beginning of this column, annuities can be complicated. But there’s one aspect of them that’s become painfully obvious: Getting into them is a lot easier than getting out.

Question: My 401(k) is invested entirely in stocks and has dropped 30% over the last two months. Should I move my account out of stocks now, or should I wait for my account balance to go back up and then move it into bonds until the market stabilizes? I’m afraid I’m going to lose even more. Help! —Leslie, Fairfield, Connecticut

Answer: It’s natural in uncertain times like these with financial markets reeling around the globe and no one sure whether last week’s bailout package will work, that you would want to do something, anything, to stem the bleeding in your 401(k).

I mean, just about any move you make has got to be better than staying in stocks and watching your 401(k)’s balance continue to dwindle, right?

Wrong. Switching your 401(k) money into bonds or even cash for that matter may make you feel better in the short-term. But by allowing fear and panic to dictate your investing strategy, you are undermining your long-term prospects for a comfortable retirement.

So I suggest you stifle the urge to flee stocks completely and hunker down in a temporary safe haven. Instead, you need to take a deep breath, step back and assess this situation coolly and rationally.

The sky isn’t falling

The first thing you need to know is that, despite the steady drumbeat of bad news about the stock market and frozen credit markets, the U.S. economy isn’t going to disintegrate. Yes, we’re probably in or entering a recession. When we’ll come out of it, frankly, no one knows for sure. Recessions typically last about 10 months, but the length and severity of this one depends a lot on how well the bailout package works and how much the housing market continues to drag down the rest of the economy.

The point, though, is that the economy and the markets will rebound from this crisis just as we’ve recovered from the Crash of ’87, the Asian crisis of 1997, the Long-Term Capital Management debacle in 1998 and 10 recessions since World War II.

Stocks aren’t dead

The second thing you need to remember is that stocks still offer you the best shot at the long-term capital growth you’ll need to build a nest egg large enough to sustain you through retirement. I realize that notion may be a hard sell given that the stock market is down more than 20% for the year to date, and that stock returns have actually lagged those of bonds over the past 10 years. Occasional steep setbacks in stock prices are nothing new, however. And while stocks’ performance over the past 10 years has been discouraging, it’s also an anomaly.

Of the 73 rolling 10-year periods since 1926 (1926-1935, 1927-1936, etc.), stocks have outgained bonds 85% of the time. And if you extend the period to 20 years, it’s a near clean sweep with stocks winning 98% of the time.

There’s no assurance that the future will reprise the past. Then again, the case for stocks is even stronger if you invest in them when they’re selling at prices well below their previous highs, as is the case today.

As for your plan to get out of stocks now with the idea of moving back in when things stabilize, I don’t recommend it. Stocks typically lead an economic recovery. So by the time you feel more comfortable about investing, the market may have already begun to rally. And if you aren’t there for the initial stages of a stock-market rebound, you may be giving up some big returns.

When the market exploded from its low in the 1982 recession, for example, it gained 59% over the next 12 months. But 70% of that return – fully 40 percentage points – came in the first six months. If you’d been sitting in cash those six months, you would have earned just 4%. And even if you’d been able to react quickly enough to move to stocks at that point – a debatable assumption since it’s hard to know whether an upturn is the real deal or a bear-market rally that will fizzle – you would have ended up with only a 19% gain for those 12 months instead of 59%.

Fix your mix

Alas, neither I nor anyone else can guarantee when the market will recover or how quickly it will take off. But if you want to participate in the rebound as well as stocks’ superior long-term returns, you want your 401(k) account to be positioned to take advantage of it.

The way to do that is to set a mix of stocks and bonds based on how much risk you’re comfortable taking and when you plan to retire. The younger you are, the more you should tilt the mix in your 401(k) toward stocks. You don’t have to be so concerned about stock-market setbacks – even particularly frightening ones like yesterday’s – since you’ve got plenty of time to bounce back.

There’s no ideal mix that’s right for everyone, but generally if you’re in your 20s or 30s and retirement is a good 30 or more years away, you should probably have between 80% and 90% of your retirement savings invested in a diversified group of stock funds and the rest in less volatile options like bond funds and/or stable-value funds.

As you get older and have less time to recoup stock market losses, you want to gradually scale back the percentage of your 401(k) that you devote to equities, although you still need the growth potential of stocks. So by the time you’re in your 50s, you still probably want to have 70% or so of your retirement portfolio in stocks and perhaps 60% or so by the time you’re 60.

As a guide to setting the stocks-bond mix for your 401(k), you might check out a target-date retirement fund with a year that corresponds to the year you plan to retire (2020, 2030, 2040, whatever). Or you can create your own stocks-bonds mix with our Asset Allocator tool.

I think investing 100% of your 401(k) in stocks is being a bit too aggressive for nearly all investors. It’s the kind of approach people adopt when the market is flying high and downturns seem like only remote possibilities – and they then come to regret when the harsh reality of a bear market sets in.

What you don’t want to do, though, is get so freaked out by the current crisis that you dump stocks altogether and huddle in your plan’s most conservative options. That may keep your 401(k) balance from declining now. But you’ll likely be relegating yourself to subpar long-term returns and setting yourself up for a more devastating setback later in life – entering retirement with a nest egg that’s too small to support you.

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