401(k)s can sometimes seem like a temperamental friend. Sometimes your investments will perform to your satisfaction and sometimes they will end up disappointing you. With the ongoing market volatility, you may become frustrated with your 401(k)’s behavior more often than not. And if you are a younger investor, retirement planning may have confounded you from the moment you enrolled.

Volatile and seemingly unpredictable at times, 401(k)s can cause some plan participants to throw their hands up in the air and wonder if this friendship is worth all the trouble. However, don’t let your 401(k)’s chaotic nature sabotage your desired retirement future. Sometimes it just takes a step back or a “time out” to reevaluate your retirement connection.

When your 401(k) needs a behavior adjustment, these three steps can help you reevaluate and readjust.

Rebalance your portfolio.

If you leave your investments unchecked, your balances in each of the asset classes will stray away from the initial target allocation. If you want your investments to keep up with the market’s ups and downs, you will need to rebalance your portfolio on a regular basis. When your retirement plan has been neglected, it’s important that you step in to readjust your investments so that they realign with your retirement goals.

Raise your contribution amount.

Many financial advisers recommend increasing your contribution amount by 1 percent each year. However, not everyone is in the ideal financial situation to do so. Therefore, at least try to increase your contribution amount with each raise or promotion.

Most Americans need to increase their contribution amount to a work retirement plan over time in order to reach their retirement goals. Although retirement may seem far away, you only have one shot to prepare, so it’s important to do everything you can now for what’s ahead.

Avoid chasing after short-term relief.

Even though we all look for ways to achieve immediate satisfaction, that mentality is dangerous when it comes to your investments. Although the market instability might cause your retirement plan to act up, avoid making sudden investment moves to gain short-term relief. For example, moving your entire portfolio to cash following a significant market downturn could hurt your long-term return potential, as you could miss out on the potential rebound. It is far better to develop a solid plan from the start and stick with it through both the ups and downs.

Retirement planning is a long-term process that takes patience, so it’s crucial to stay levelheaded when you hear or see something like, “The market is down.” Remind yourself that the “market” can mean different things in different contexts. The statement could be referring to the S&P 500, the Dow, housing, commodities, emerging markets, etc.

Depending upon your exposure to the “market” being discussed, you may not be as impacted as you might expect. For example, the S&P 500 and the Dow are benchmarks to describe the general market environment and some of your investments may not even be part of those indexes.

401(k)s or any other retirement plan can be very temperamental, especially given the recent market volatility. However, with patience and commitment, you have the ability to set your retirement account on the right track.  Just as you would take the time to build a life-long friendship, you should take the time with your 401(k) as well.

Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.

Many 401(k) holders don’t really know what a 401(k) is. They just understand that it’s a method by which they defer immediate financial gratification in exchange for having enough to live on during “retirement,” a concept so far in the future for most of us that it might as well be riding a hoverbike.

It’s important to understand that a 401(k) is an investment vehicle, not an emergency fund. Nor is it a vacation savings account, nor a Christmas petty cash envelope. The idea is to hold onto the money inside your 401(k) and let it snowball, month after month, until doing so becomes habit. Then, decades later, you’re enjoying something approaching affluence instead of eating cold soup out of tin cans. Withdrawing before you get there defeats the purpose. And there’s plenty of disincentive to withdraw early.

Allowed to Borrow

Some employers do let you borrow up to half the value of your 401(k). You have to pay back the loan in five years, and it’ll be restricted to medical expenses, education, home buying or stopping your home from getting foreclosed upon. Your employer has to pay to administer any loan you make, which is why they’re not going to let you use a loan to pay for a trip to Europe. Not that you would do that anyway. And if you borrow against your 401(k) and then lose your job, your 401(k) stays intact but you have to pay the loan back immediately. You know, because when you’re out of a job the first thing you want to do is have all your long-term bills instantly come due.

If you want to withdraw money before you turn 59.5, your 401(k) will literally be decimated. You’ll pay a crushing 10% penalty. Oh, and you’ll get to pay taxes on what you withdraw, too. Unless you’re withdrawing money for one of the above activities deemed acceptable by the Internal Revenue Service.

Loans from your 401(k) sound counterintuitive on the surface. Aren’t you really just borrowing from yourself? But this isn’t merely pulling money out of your right rear pocket and moving it to your left front. On some level, it’s reneging on an agreement. The agreement not to commingle the finances of your present self and your future self. If you’re committed to doing so, understand that you’re restricted to either half what you’ve amassed, or $50,000 – whichever is less.

Mark Twain said that man is distinguished from the animals not so much by his ability to reason, but by his ability to rationalize. In that spirit, many people blatantly use 401(k) savings to pay for junior’s college education. Never mind that a non-hard sciences degree is a notoriously poor investment, some parents can’t be swayed from the notion that a degree must be achieved at all costs. Including some costs, like 401(k) loans, that never should have been incurred in the first place.

Not Even to Buy a House

The same goes for home ownership, or foreclosure avoidance. If you’re thinking of tapping into retirement to buy a house, the arguments for not doing so are varied and ironclad. While owning a home is a laudable goal, and borrowing is probably necessary to achieve that goal, there are better places to borrow from. Particularly in 2011, when a static currency means that mortgage lenders are closing in on the theoretical minimum rate for fixed mortgages. Four percent is a better rate than the future you can offer the present you, and it won’t cut into your retirement, either.

If you already own a home, have missed multiple mortgage payments, and the only thing stopping the constable from evicting you is an emergency loan from your 401(k), cut off the finger to save the hand. There’s no sense in losing two necessities, your home and your future.

The Bottom Line

One of the first concepts freshman economics students learn is that of the price of money, better known as the interest rate. Money from a family member is relatively inexpensive, sometimes even free. Money from a loan shark can be the costliest you ever borrow. Not far behind that is money that erodes your retirement savings, and that comes with a federally mandated 10% penalty and a non-negotiable five-year term.

“The Pitfalls of Borrowing From Your 401k” was provided by Investopedia.com.

The end of the year is a good time to review your personal finances. What are your financial, business, or life priorities for 2012? Try to specify the goals you want to accomplish. Think about the consistent investing, saving or budgeting methods you can use to realize them. Also, consider these year-end moves.

1. Think about adjusting or timing your income and tax deductions.

If you earn a lot of money and have the option of postponing a portion of the taxable income you will make in 2011 until 2012, this decision can bring you some tax savings. You might also consider accelerating payment of deductible expenses if you are close to the line on itemized deductions – another way to potentially save some bucks.

2. Think about putting more in your 401(k) or 403(b).

In 2011, you can contribute up to $16,500 per year to these accounts, with a $5,500 catch-up contribution also allowed if you are age 50 or older. Has your 2011 contribution reached the annual limit? There is still time to put more into your employer-sponsored retirement plan.

The IRS has announced 2012 contribution limits for 401(k) and 403(b) accounts, most 457 plans, and the federal government’s Thrift Savings Plan (TSP). The annual contribution limit for each of these retirement plans will be $17,000 next year; the catch-up contribution again maxes out at $5,500.

On a related note, SIMPLE IRA contribution limits won’t change next year. Up to $11,500 can be contributed to a SIMPLE IRA in 2012, $14,000 if you are 50 or older.

3. Can you max out your IRA contribution at the start of 2012?

If you can do it, do it early – the sooner you make your contribution, the more interest those assets will earn. (If you haven’t yet made your 2011 IRA contribution, you can still do so through April 17, 2012.)

The IRS has decided that IRA contribution limits won’t increase next year. In 2012 you will be able to contribute up to $5,000 to a Roth or traditional IRA if you are age 49 or younger, and up to $6,000 if you are age 50 and older (though your MAGI may affect how much you can put into a Roth IRA).

The IRS has also boosted the income limits for a tax deduction for traditional IRA contributions. If you participate in a workplace retirement plan in 2012, the MAGI phase-out ranges will be $58,000-68,000 for singles and heads of households and $92,000-112,000 for couples. (In 2011, those phase-out ranges are set $2,000 lower.) If you own an IRA, you aren’t covered by a workplace retirement plan, and you are married and filing jointly, the 2012 phase-out range is $173,000-183,000 based on a couple’s combined MAGI, hiked by $4,000 from 2011.

4. Should you go Roth between now and the end of 2012?

While you can no longer divide the income from a Roth IRA conversion across two years of federal tax returns, converting a traditional IRA into a Roth before 2013 may make sense for another reason: Federal taxes might be higher in 2013. Congress extended the Bush-era tax cuts through the end of 2012; that sunset may not be delayed any further.

Some MAGI phase-out limits affect Roth IRA contributions. These phase-out limits have been adjusted north for 2012. Next year, phase-outs will kick in at $173,000 for joint filers and $110,000 for single filers. (The 2011 phase-outs respectively kick in at $169,000 and $107,000.) Should your MAGI prevent you from contributing to a Roth IRA at all, you still have a chance to contribute to a traditional IRA in 2012 and then roll those IRA assets over into a Roth.

Consult a tax or financial professional before you make any IRA moves. You will want see how it may affect your overall financial picture. The tax consequences of a Roth conversion can get sticky if you own multiple traditional IRAs.

5. If you are retired and older than 70½, don’t forget an RMD.

Retirees over age 70½ must take Required Minimum Distributions from traditional IRAs and 401(k)s by December 31, 2012. Remember that the IRS penalty for failing to take an RMD equals 50% of the RMD amount.

If you have turned or will turn 70½ in 2011, you can postpone your first IRA RMD until April 1, 2012. The downside of that is that you will have to take two IRA RMDs next year, both taxable events – you will have to make your 2011 tax year withdrawal by April 1, 2012 and your 2012 tax year withdrawal by December 31, 2012.

Plan your RMDs wisely. If you do so, you may end up limiting or avoiding possible taxes on your Social Security income. Some Social Security recipients don’t know about the “provisional income” rule – if your modified AGI plus 50% of your Social Security benefits surpasses a certain level, then a portion of your Social Security benefits become taxable. For tax year 2011, Social Security benefits start to be taxed at provisional income levels of $32,000 for joint filers and $25,000 for single filers.

6. Consider the tax impact of any 2011 transactions.

Did you sell any real property this year – or do you plan to before the year ends? Did you start a business? Are you thinking about exercising a stock option? Could any large commissions or bonuses come your way before the end of the year? Did you sell an investment that was held outside of a tax-deferred account? Any of these moves might have a big impact on your taxes.

7. You may wish to make a charitable gift before New Year’s Day.

Make a charitable contribution this year and you can claim the deduction on your 2011 return.

8. You could make December the “13th month”.

Can you make a January mortgage payment in December, or make a lump sum payment on your mortgage balance? If you have a fixed-rate mortgage, a lump sum payment can reduce the home loan amount and the total interest paid on the loan by that much more. In a sense, paying down a debt is almost like getting a risk-free return.

9. Are you marrying next year, or do you know someone who is?

The top of 2012 is a good time to review (and possibly change) beneficiaries to your 401(k) or 403(b) account, your IRA, your insurance policy and other assets. You may want to change beneficiaries in your will. It is also wise to take a look at your insurance coverage. If your last name is changing, you will need a new Social Security card. Lastly, assess your debts and the merits of your existing financial plans.

10. Are you returning from active duty?

If so, go ahead and check the status of your credit, and the state of any tax and legal proceedings that might have been preempted by your orders. Review the status of your employee health insurance, and revoke any power of attorney you may have granted to another person.

11. Lastly, have you reviewed your withholding status?

-It may be time for a withholding adjustment if…
-You tend to pay a great deal of income tax annually.
-You tend to get a big refund each year from the IRS.
-You recently married or divorced.
-A family member recently passed away.
-You have a new job that pays you much more than your old one.
-You opened up your own business or started freelancing.

12. Don’t delay – get it done.

Talk with a qualified financial or tax professional today, so you can focus on being healthy and wealthy in the New Year.

Bill Losey, CFP®, CSA, America’s Retirement Strategist®, is a highly sought-after advisor, retirement authority, thought-leader, author and national TV personality. The former resident retirement expert on CNBC’s “On the Money”, Bill has over 20 years experience in the financial services industry and is a Certified Financial Planner practitioner, a Certified Senior Advisor and Certified Retirement Coach. For more information please visit, www.BillLosey.com.

In his 1978 classic Alice, Let’s Eat, Calvin Trillin introduced the world to his late wife Alice’s “Law of Compensatory Cashflow.” It goes like this: “Money not spent on a luxury one considered even briefly is the equivalent of windfall income and should be spent accordingly.”

Is there anyone in our society who doesn’t know the feeling? Just today, I was seriously thinking about buying some fancy new headphones. (My wife will confirm that I’m not given to luxury impulse purchases except, for some reason, when it comes to headphones.) The headphones cost about $100. I may or may not buy those exact headphones, but now I’m predisposed to spend $100 on something I don’t need. If only someone could harness this feeling and use it as a force for good.

Enter Putnam Investments and their innovative Price Check & Save app, available free for iPhone. (Yes, they’re definitely thinking about Android and Windows Phone 7, too.) The app is available only to participants in Putnam 401(k) plans, roughly 300,000 Americans.

Like another great innovation, the Reese’s Peanut Butter Cup, the Putnam app takes two ideas you’ve seen before and fuses them together to great effect. Here’s how it works. You’re at the store browsing headphones. (Okay, fine, I’m at the store browsing headphones.) Launch the app and scan the packaging barcode. If this sounds like the popular free RedLaser app, it’s because Putnam licensed RedLaser and embedded the technology in Price Check & Save.

RedLaser searches the Web to and shows you the lowest available price for the item you scanned. Putnam’s app shows you the highest price. Due to a powerful effect called price anchoring, your brain now assumes that these headphones are worth $100, and anything less is a discount.

Now, you can go ahead and buy the headphones. Or you can press the button that says “Save to 401(k),” and $100 will disappear into your retirement plan. Furthermore, the app will taunt you by showing you how much monthly income that $100 will turn into in retirement if you save it instead of buying your eighth pair of headphones. (The app can make a good guess because you’ve signed into your 401(k), which knows how old you are and what types of investments you hold.)

Or you can compare prices. Say Price Check & Save finds the same headphones at another store for $75. Now you can hit the button and save the difference, $25, to your 401(k). The money is withheld from your next paycheck along with your regular 401(k) deferral. Yes, your plan will make sure you don’t go over your 401(k) limit or try to save more than your entire paycheck.

The point, says Ed Murphy, Putnam’s head of defined contribution, is to “not necessarily discourage people from purchasing things—we’re all consumers—but help people understand the implication of those decisions for their retirement.”

Chris Farrell, author of The New Frugality, did a radio commentary about impulse savings in which he fantasized about a red button in your house that would instantly transfer $50 into your 401(k). I asked him whether the Putnam app fulfills the dream. “It looks very cool,” says Farrell. “Taking advantage of insights from impulse spending and translating them into encouraging impulse savings is a real advance.”

So crazy it just might work

Putnam deserves serious props for this cool idea. But it’s not the only savings innovation around. For several years, Bank of America has offered the Keep the Change program, which rounds up all debit card purchases to the next dollar and deposits the difference in your savings account. It’s not enough to fund your retirement, but it couldn’t hurt.

There’s also SmartyPig, which I seem to recommend pretty much every week. It’s a savings account that lets you easily split up your savings into individual goals. (It offers iPhone and Android apps.) One thing I like about SmartyPig is that it makes it much easier to make deposits than withdrawals. To add money to a goal, you just click a couple of times. To withdraw from a goal, you have to liquidate the whole amount, answer a series of questions, and then wait a couple of days for the transfer to process. It feels exactly like Mom saying, “Are you sure you want to spend your entire allowance on headphones?”

My friend Roger suggested another approach. “I’m imagining some sort of watch on your pay deposits (that’s something regularly-employed people have, Matthew),” he says. Thanks. “And if your pay exceeds the usual amount, the excess is automatically skimmed off into some savings account.” Some 401(k)s let you elect to automatically increase your savings rate over time, but I don’t know of one that automatically hijacks your bonus. Good idea.

You can, of course, implement a Price Check & Save-like strategy with your IRA or savings account. Check a price using the regular RedLaser app, then put down the shiny product box, switch to your brokerage or bank app, and initiate a transfer.

In fact, I could do that right now. But it’s just enough of an extra hassle that my good intentions are melting away, like the difference between one-click ordering and a shopping cart. Speaking of which, there’s only one click between me and some new headphones.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.

If you’re like the average American, retirement savings has you totally bummed out. The Employee Benefit Research Institute (EBRI) reports that 27 percent of Americans are “not at all confident” about having enough money for a comfortable retirement, and only 13 percent are “very confident.”

You don’t have to go far to find other scary retirement savings figures, like how the average working person in their 60s has only $144,000 in their 401(k). At a recommended 4 percent withdrawal rate, that’s enough to produce $5,760 per year in retirement income. Ouch.

I don’t want to minimize how scary it is out there for the retirement saver. But I’m an upbeat guy, and I want to inject a Pollyanna-tinged ray of sunshine into this gloomy glade. You may not be as far behind on retirement savings as you think you are, and if you are genuinely behind, it may be easier to catch up than you think.

The standard model of retirement planning assumes you’ll take money you’ve accumulated in your 401(k) and other investments and withdraw it gradually over the rest of your life to replace the salary you were receiving at the time you retired. In order to keep up with inflation but minimize the risk of outliving your money, various studies have found that you can withdraw 4 percent of your portfolio in the first year and an equivalent amount, adjusted for inflation, each year thereafter.

In math terms, the standard model goes something like this:

Your salary × 25 = Your retirement goal

You see this formula all the time. Here’s how the Motley Fool put it: “So if you’re planning to live comfortably on $50,000 a year in retirement, you’ll need to have $1.25 million saved by the time you get there.” Plenty of online retirement calculators make the same assumption.

But even if you assume Social Security will disappear by the time you retire, that number is way too high. Here are five reasons why.

1. You won’t be saving for retirement any more when you’re retired

If you’re putting 10% of your salary into your 401(k), that’s 10% you won’t need to replace in retirement. This is an absolute no-brainer, but it has some interesting consequences we’ll get to in a minute.

2. You’ll spend less, year after year

People in their 80s are different from people in their 30s, 40s, and 50s in plenty of ways beyond wise aphorisms and Metamucil. As we get older, we spend less.

In a 2005 paper, financial planner Ty Bernicke offers evidence that spending drops off precipitously as we move into our 60s and 70s. (People in the 55-64 range even spend less than those aged 45-54.)

That’s even taking into account the fact that the elderly spend more on health care, and it holds even for wealthy retirees whose net worth is steadily increasing. That is, even retirees who are sitting on an ever-growing pile of loot for their heirs tend to voluntarily decrease their spending.

Facing down this data is kind of unnerving in the same way thinking about wills and life insurance is unnerving: I don’t want to think about slowing down, traveling less, spending less on food and entertainment, any more than I want to think about eventually spending zero on these things for eternity. But taking what Bernicke calls a “reality” approach to retirement planning could enable a typical retiree to save less or retire earlier.

3. Your tax bracket will go down

Most retirees are in the lowest tax brackets. Money you take out of your 401(k) or traditional IRA is taxable, but Social Security is only partly taxable, and Roth IRA distributions aren’t taxable at all. Sure, the tax code is going to change a dozen times between now and when you retire, but chances are, your taxes are going go down the day you kiss that cubicle goodbye.

If you’re budgeting for retirement based on the assumption that you’ll spend as much on taxes as you do today, you’re budgeting too much.

4. You can always annuitize

If your retirement savings are marginal (but not way below par), you can turn them into a lifetime monthly income stream by buying a single-premium immediate annuity (SPIA) from an insurance company. Basically, you hand the money over to an insurance company and it gives it back, with interest, over the rest of your life. If you live longer than the insurance company expects, you win. Even in the current low interest rate environment, an inflation-adjusted SPIA pays over 4 percent annually if you annuitize at age 65.

Annuities are backed, up to a maximum, by a state guaranty agency. And you don’t have to make an all-or-nothing decision at 65. You can annuitize some of your money—maybe enough to guarantee a minimum base level of income you don’t want to drop below—and invest the rest. You can wait until you’re 70 and see how things look then; the older you are, the bigger the monthly payout from a SPIA. And interest rates could go up.

5. Every dollar you save reduces your current standard of living

Ah, “reduces your current standard of living” is such a negative way to put a beautiful concept.

Here’s what happens if you decide to bump up your retirement savings by 2 percentage points today—say, from 8% of your paycheck to 10%. For a couple of months, you grumble about your smaller paycheck. Then you get used to spending slightly less and forget about the supposed good old days. Your retirement account will grow faster, and by the time you need to draw upon it, you’ll be able to make smaller withdrawals thanks to your lower standard of living.

In other words, you have more savings to replace less spending. It’s like the universe just gave you a 401(k) match. If you took that extra 2 percent and gave it to charity or sent it to me every month instead of saving it, you’d still be better off, because you’d be saving at the same rate as before but have less spending to replace.

Hmm, did I just prove you’d be more financially secure if you sent me some money? I reckon so.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.

Hey, groovy gals and guys, let’s take the investing Wayback Machine to 1973. What’s this? No 401(k)s? No IRAs? No exchange-traded funds? No index funds at all!

In other words, investors were screwed. Into this wasteland came A Random Walk Down Wall Street, by an economist, Burton Malkiel, who compared stock market analysts to dart-throwing monkeys and argued that we’d all be better off if we could just invest directly in the S&P 500. Two years later, John Bogle established the first index fund (the Vanguard 500, VFINX). If you own an indexed stock or bond fund–and you should–you owe a debt to Burt Malkiel.

Random Walk came out in its tenth edition this year. It now covers behavioral finance (that is, stupid investor tricks), the ongoing economic crisis, financial innovations good and bad, and why indexing still wins. Malkiel, 78, is professor of economics at Princeton University and spent nearly three decades as a director at Vanguard. He spoke with MintLife’s Matthew Amster-Burton.

This is part one of two.

The bad old days

MintLife: Take me back to 1973, when the first edition of Random Walk came out. What does the investing landscape look like? There are no index funds, no IRAs. What are my options?

Malkiel: What you typically had at that time were full-service brokers, and the biggest one was Merrill Lynch. If you made a modest, say, $1,000 or $2,000 investment, you would have a registered representative, usually suggesting a stock to you, and you would pay a commission that might be as much as $100. So that was the investing landscape.

Alternatively, the registered representative would say, “Hey, you need diversification. You ought to buy this mutual fund.” And the typical mutual fund at the time had a 7% load fee. So a $2000 investment might mean $140 in essentially a commission, of which the registered representative would get a certain proportion of it, usually 30, 35%, depending on the broker. So I would say that that was the investing landscape then, in that most of the mutual funds were load funds. There were no index funds.

And the view was, when my book first came out, “What a stupid thing to say. We know that investment professionals can do much better than the market.” And there was certainly a view that people couldn’t do things on their own. They needed these professional brokers, professional investment managers, and it was ridiculous to think that anybody could do it on their own. The idea of buying a dumb index fund was absolutely stupid.

MintLife: It’s amazing to me that you hear this criticism these days that the system is rigged against the individual because of high-frequency trading and institutional dominance of the market. It seems like it was much more rigged against the individual then.

Malkiel: I think that’s absolutely right. In fact, on high-frequency trading, look, there are some bad things you can do, like these kind of flash orders that are trying to manipulate the market that really aren’t real orders. So I’m not saying everything that’s done there is right. But one of the things that I like about it is, since I believe in index funds and ETFs, which now are the biggest growth investment product that there is, with way over a trillion dollars in it–the reason I like high-frequency trading is that it means that those things are going to be efficiently priced.

I want the guy on the street who buys a SPDR, or who buys VTI, which is the Vanguard Total Stock Market ETF–these things with less than ten basis points (0.1%) of expense–I want to make sure that they are priced appropriately relatively to the underlying stocks. Take the example of the SPDR. If the SPDR, which is an S&P 500 ETF, if it gets a little bit out of line with the underlying stocks, what the high-frequency trader does is–say the ETF is too high–short the ETF, buy the individual stocks, trade them in for ETF shares to cover the short. And this is a good thing, because what it means is, the guy on the street’s getting the right price.

So I think if anything, these things make the market more efficient and make it more likely that the individual will do, in my view, not only as well as the experts but better. And if there are a couple of loose pennies for the high-frequency traders to pick up, that’s terrific, because that makes the market more efficient.

The LinkedIn IPO and efficient markets

MintLife: Let’s talk about market efficiency. You hear lots of objections to the efficient market hypothesis, and I think a lot of them have to do with the name. People have this idea that saying that the market is efficient is equivalent to saying that the market should never go down.

Malkiel: That’s a very good point, because I think people misrepresent what the efficient market hypothesis means.

MintLife: So what does it really mean?

Malkiel: Okay, here’s what it really means. First of all, let me say what it doesn’t mean. What it doesn’t mean is that the price is always right. How could prices be right? The price of a stock, what I teach my students is, that any stock is worth the discounted present value of all of the future cash flows. So what does that mean? That means that somebody’s got to estimate a bunch of future cash flows, and nobody knows what they’re going to be. Is LinkedIn (LNKD) a bubble or not? Well, who the hell knows what the future cash flows are going to be for LinkedIn?

Nobody knows! And some people are going to think it’s a bubble because the market is discounting tremendous growth, and other people will think, hey, you don’t understand, this is really something new, and this is something that is just in its infancy, and the amount of earnings that you’re going to get from it is going to be absolutely enormous. When Google came out, people thought, oh my God, it’s a bubble, it’s a terrible thing, and in fact, Google turned out to be cheap. On the other hand, Pets.com turned out to be, if you’ll pardon the expression, a dog.

So nobody knows. The efficient market hypothesis doesn’t mean the market’s always right. The market’s always wrong. But nobody knows whether any price at any time is too high or too low. So what does it mean? What is does mean is that there are no arbitrage opportunities, by which I mean: the market, it may not be right, and in fact it’s always wrong, but nobody can beat the market.

Now, if a hedge fund is long stocks and the stock market goes up and they’re leveraged up to the eyeballs, they will beat the market, but they’ve taken on much more risk. Sometimes 25% of hedge funds go out of business in a year.

MintLife: What do you think of the argument that, okay, indexing, that’s just one philosophy among many. You can be an indexing kind of person, you can be a “watch the 200-day moving average” kind of person, and it’s just a matter of taste and there isn’t a preponderance of evidence one way or the other.

Malkiel: Well, there is a preponderance of evidence, I believe. To take your example, is the technician who follows the 200-day moving average going to do any better than the index guy? What I’ve done in every edition of the book is to say, okay, this was a thesis, that the index fund is going to do better than the vast majority of professional managers, so did it work? And every time I do the book, including the 2011 edition, I look at the data and ask whether it worked, and I would argue that the data are very clear that it works and it continues to work.

I’m not that sort of super extreme and dogmatic, but what I do say–and this is in the 10th edition–there’s at least enough evidence that indexing isn’t average, it’s above average. There’s enough evidence that it works that at least the core of one’s portfolio ought to be in index funds. Then, you know, investing’s fun. You want to go out and buy some individual stocks? You really think LinkedIn is the way to go? Go do it! You can then do it with much less risk if the core of your investment fund is indexed. So what’s in the book is kind of a core-satellite approach, and it’s really based on evidence. The evidence is that it works.

MintLife: I had someone ask me how he could use his 401(k) to buy into the LinkedIn IPO, and I said, “Maybe consider using some fun money for that instead.”

Malkiel: Well, exactly. In other words, your important money, your 401(k) money ought to be in index funds. You want to have a little fun? And it is fun. Investing is fun. I buy some individual stocks. But I can do it with much less risk because my core IRA money, and at universities we have something called a 403(b), which is the same as a 401(k), that’s basically invested in index funds.

This interview has been condensed and edited.

Photo: iStockphoto

Recently I wrote about how to simplify your portfolio down to three basic low-cost index funds. I assumed that a couple would have four retirement accounts: two 401(k)s and two IRAs.

Reader Jason asked why we couldn’t simplify this even further:

Why should you have an IRA and a work portfolio? Depending on your match situation should you go all in at the work 401(k) and get the best match?

Jason, you should always contribute enough to your 401(k) to get the maximum employer match. This is the only thing that literally everybody in the personal finance game agrees on. If we ever make contact with intelligent alien life, the first thing financial planners will ask the aliens is whether they’re maximizing their employer match.

But there are still plenty of good reasons to have an IRA in addition to your 401(k) (or 403(b), or 457). I spoke with two certified financial planners, and we came up with five good reasons.

1. Your 401(k) sucks

Too many 401(k)s are stuffed with expensive mutual funds designed to transfer money from your paycheck to a fund manager. Large companies tend to have great 401(k)s. Small companies? “I work with employees of many different types of companies, many of which are small,” says Dave O’Brien, a certified financial planner in Richmond, Virginia. “Your plan is probably expensive as all get-out.”

How can you tell? Each fund in your plan has an expense ratio, expressed as a percentage. If a fund’s expense ratio is 1 percent and you have $1,000 in it, you pay $10 this year in expenses. Over time, this adds up.

Your 401(k) is required to disclose this information, and more than 1 percent in expense ratios is too expensive. Good 401(k)s offer funds that charge less than 0.1%. Also, look for those five-letter mutual fund ticker symbols. “If there’s no ticker symbol, that’s a red flag,” says O’Brien, who also consults with companies designing 401(k)s. Missing tickers often indicates that your 401(k) is run by an insurance company rather than an investment company–and that often indicates high costs.

If your 401(k) stinks, you should still hold your nose, look for the best funds of the sorry bunch, and contribute up to the match. After that, though, put the next $5,000 into your IRA, says O’Brien. “Get the employer match, then put your money elsewhere,” he says. “Go for one of the low cost places—Vanguard, Fidelity.”

2. You can “tax diversify” by having both a 401(k) and a Roth IRA

Gallons of virtual ink have been spilled debating Roth vs. traditional IRA. Here are two typical arguments:

• -You should use a Roth IRA. Taxes are sure to go up and you should pay them now and get it over with.
• -You should use a traditional IRA. Take the tax break now before Congress changes its mind and starts taxing Roth IRAs.

Unfortunately, it’s impossible to know in advance which will be better unless you can foresee your own future and read the mind of Congress, which does not, technically, have a mind. “We don’t really know what is coming down the pike,” says Tim Maurer, a CFP with the Financial Consulate in Baltimore.

If you have a traditional (non-Roth) 401(k), as most people with 401(k)s do, it works like a traditional IRA: you pay no taxes when you put money in, only when you take it out. Combine that 401(k) with a Roth IRA, which works the opposite way, and you have a chocolate and peanut butter scenario: two great tastes, etc. Once you’re retired, you can withdraw the money in whatever way will make the IRS least flush: Roth first, 401(k) first, or some combination.

Furthermore, says Maurer, a Roth offers flexibility that a 401(k) doesn’t, because you can withdraw Roth contributions (but not interest) at any time without penalty. That money can be used for an emergency, college tuition, or a house down payment. He’s not saying you should steal from your retirement to buy these things, obviously. But if you need to take an early withdrawal, having a Roth to take it from is a lot better than being saddled with a 401(k) loan or a 10% penalty and tax bill. “The fact that the Roth exists, and that you can tap it if you absolutely need to, makes it a more attractive option,” says Maurer.

3. Your current 401(k) doesn’t allow incoming rollovers, and you have an old 401(k) (or two, or three) to consolidate

An incoming rollover is when you take money from an old 401(k) and put it into your current 401(k), with no penalty or tax consequences. Only some plans allow incoming rollovers, and it’s usually a bad idea. If you have a lousy, expensive 401(k) like Dave O’Brien warned you about, why would you put more money in there than you have to? This silo is rat-infested? Great, let’s store all our grain there!

But keeping money sitting around in old 401(k)s is also a bad idea, because those plans are probably just as expensive, and it makes it hard to understand your overall portfolio. You can do a direct rollover into an IRA, pay no tax, and have access to low-cost mutual funds at any major fund company.

Occasionally, however, an incoming rollover makes sense. “It’s a good idea if your new employer’s retirement plan offers you broad diversification, total transparency, and low cost,” says O’Brien. The quintessential example? The federal government’s Thrift Savings Plan ( TSP ), the country’s best 401(k), available to federal employees and members of the armed forces. “You can’t get better than TSP,” says O’Brien. And it allows incoming rollovers.

4. You’ve maxed out your 401(k) and still have more money to save

Self-explanatory, right? The maximum 401(k) contribution for a person under 50 is $16,500. For 50 and over, it’s $22,000. If you contribute more than this, you’re the LeBron of savings. You probably also make too much to contribute to a deductible IRA, so look into doing a backdoor Roth.

5. You might learn something

A 401(k) offers a default investment option and advice from the plan administrator. An IRA at a discount fund company offers neither. This is your opportunity to learn a little bit about investing. Curl up with a good book, like Burton Malkiel and Charles Ellis’s Elements of Investing, and 100 pages later, you’ll be pissed off at your overpriced 401(k) and ready to take charge.

I believe in you. So does Tim Maurer. “If we can’t be trusted with our own dollars,” he says, “we’re going to have a retirement without prosperity.”

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.

Tax season is over. It’s time for some portfolio spring cleaning. Let’s Roomba this sucker.

We’ve told you before why it’s important to roll over your old 401(k)s and other workplace retirement plans into an individual retirement account (IRA). It usually saves you a bundle on fees and expenses. It gives you access to better investment options. It makes your portfolio more comprehensible and easier to manage. And Mint can get you started. If you’ve worked a bunch of jobs (who hasn’t?) and left a mess of 401(k)s, 403(b)s, and SIMPLE IRAs in your wake, now’s the time to consolidate them. Get it over with.

Even if you’ve been diligent about rolling over old plans, however, you’re probably holding too many mutual funds. Walk into the office of a financial advisor—especially one who works on commission, and you’ll probably be talked into splitting your money among six, ten, twelve funds (I’ve also seen fee-only advisors do the same).

Why do they do this? One reason is that it reinforces the idea that investing is too complicated for you to handle yourself, and you should leave it to the experts who understand the difference between growth stocks and midcap stocks and international REITs and junk bonds. So when it comes time for annual rebalancing, you need to go back to the advisor. Bring your wallet.

Well, this is (to use a technical term) horse poop. We’re going to wean you down to the only funds you really need to get the job done.

Cut the clutter

Assuming you and your spouse work for The Man (i.e., you’re not self-employed), here’s what you should have in your bag of tricks when you’re done rolling over:

• Two workplace retirement plans (one for each spouse)
• Two IRAs (one for each spouse)

If you’re single, your investing life is that much simpler. But don’t you long for someone to practice asset allocation with in your twilight years? Don’t answer that.

Now it’s time to decide what mutual funds to put in those accounts. For recommendations, I turned to certified financial planner Allan Roth, author of How a Second-Grader Beats Wall Street and writer of the Irrational Investor blog. You only need three funds, says Roth:

• A US stock index fund
• An international stock index fund
• A total bond market fund

“Those are the three core funds that I get clients as much into them as possible,” says Roth. “These three funds are far more diversified than your 43 funds you have now.”

(If you’re not sure how much to put in stocks and how much in bonds, let me direct you to MintLife’s ever-useful column, The Lazy Portfolio.)

The office

Start with the workplace plans. You’re at the mercy of your pointy-haired plan administrator for fund selection here. A typical 401(k) has a terrifying list of funds with names that make German wine labels look comprehensible. All you care about, however, is what’s cheap. Every fund has an expense ratio which tells you the percentage of your money paid to the fund administrator every year. Look for the word “index” and find the stock and bond index funds with the lowest expenses.

Why? As Morningstar put it, “In every single time period and data point tested, low-cost funds beat high-cost funds.” Morningstar is the company that gives star ratings to mutual funds. In its own study, Morningstar found low expense ratios were a better indicator of success than a high star rating in 58 percent of the test cases. In a workplace plan, an expense ratio under 1% is acceptable, under 0.5% is good, and under 0.2% is awesome.

You don’t have to hold all three kinds of funds in your 401(k). My wife’s retirement plan, for example, has excellent stock index funds and a lousy bond fund. So we hold almost entirely stocks in that plan and bonds in our Roth IRAs. The key is to diversify overall, not within each account. “It’s the total portfolio that matters,” says Roth. This also makes it easier to hit the minimum opening balance for the best funds, which is often $3000 or more.

Inviting IRA to the party

For the IRAs, you have your choice of any funds offered by your mutual fund provider. Roth recommends the following Vanguard funds, but all major mutual fund companies have competing index funds:

What about ETFs? What about adding real estate, small-cap value, or commodities? “If you want to, you can specifically tailor your portfolio in various ways beyond those three funds. But you don’t have to,” says Mike Piper, author of many books on investing and writer of the Oblivious Investor blog. “Those three funds are really all you need.”

Now you can get back to the important things in life, like thinking of more “asset allocation” puns.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster. Mad props to his two favorite investing books, The Elements of Investing and The Bogleheads’ Guide to Investing, for inspiring this column.

What is a 401(k)? Before you roll your eyes in a “Sheesh, is there anyone who doesn’t know the answer to that one?” way, consider this: in 2009, Fidelity Investments found that less than half (44%) of eligible workers in their 20s participated in their employer’s 401(k) plan. More than half of young employees did not set aside anything in their 401(k)s, whether by choice (they couldn’t afford to) or simply lack of understanding of their options. Like most investing vehicles, 401(k) plans can be confusing, with a multitude of investing choices, not to mention contribution rules and limitations. In this infographic, we give you the basics on 401(k) plans, in graphics.

photo: Deja Photo From Lens To Picture

How much are you paying in your 401(k)? Probably more than you think.

The typical fees and charges assessed against the average 401(k) investor can be much higher than those of equivalent investments available outside a sponsored retirement plan. The problem is, 401(k) fees can be difficult to track down and compare to alternatives. (When you invest on your own, on the other hand, you can — and should – comparison-shop different expense structures and brokerage fees. To lean more about finding the lowest brokerage commissions, watch this video at Learning Markets.) 

Don’t take 401(k) expenses lightly. It is very important to understand that these fees can make a material impact on your overall investing success. For example, an investor with a $10,000 account who pays a 1% sales charge and 3% in total annual expenses over a 20 year period will have $36,217.93 assuming a 10% annual rate of return. An investor who used ultra low-cost index funds or ETFs and paid no loads and a 0.2% annual expense ratio would have $64,634.52.

Before we launch into discussing 401(k) costs, gather some paperwork from your plan and compare the numbers. You will need your mutual funds’ prospectuses and your 401(k) plan’s annual report. You may even have to resort to a few phone calls to the plan administrator and mutual fund companies to gather all the information you need.

Fund Expenses

Mutual funds require maintenance and management. The firm offering the fund will charge an expense to its investors to cover these costs plus a profit margin. This is often called the fund’s expense ratio. A typical low-cost index mutual fund will have an expense ratio less than 1%. There are some great index funds that charge 0.2% in an annual expense ratio. (You can learn how to find and invest in fund that offer these kinds of low fees in this video at Learning Markets.)

There are several popular classes of mutual funds, including some actively managed funds,  that will charge much higher annual fees. This is not a case of getting what you pay for. There is no evidence that investors who pay high fees outperform those who pay low fees. In fact, there is evidence to the contrary. It is not unusual for an actively managed fund to charge 3% or more.  This means that if you had $10,000 invested in your 401(k), you are paying $300 per year in management expenses. 

You can find a fund’s expense ratio in its prospectus. This number is usually included in “Annual Fund Operating Expenses” section. If you can’t find it, call the company and have them show you where it is. Chances are that the harder it is to find, the higher it is.

Administrative Costs

A 401(k) plan can be expensive to administer. The company you work for is responsible for those costs and may be passing them on to you. Finding these fees can be tricky but it is usually included in the annual report you receive at the end of the year. You will need to divide the total asset value of the plan into the net expenses as shown in the end of year statement  to arrive at an expense ratio for this component of your 401(k) costs.

This portion of your account’s expenses could be as much as the expense ratio charged by the funds within the plan. That means that a 1% administration cost ratio could be costing you $100 a year if you had $10,000 invested in your 401(k).

In fact, the Wall Street Journal reported recently that many firms have learned lately that they can make so much money from your 401(k) that they will even try to keep you as a “customer” long after you’ve left as an employee.

Commissions, or Loads

What happens if you decide to leave one fund within your 401(k) and buy a different one? Are you charged for that? Sometimes the answer is yes. Charges associated with buying a fund, as well as selling one, are usually called “loads.”

A fund with a front-end load will charge you to buy the fund in the first place. This fee could be 3%-8%, which could make a serious impact on your overall performance. In a $10,000 account a 3% front-end load would cost you $300. Those are high fees just for the privilege of buying the fund.

Back-end loads, or selling charges, can be equally damaging to your portfolio’s value. These fees are triggered when you exit a fund. Sometimes, a fund will reduce this fee the longer you hold the fund, however, if you sell in the short term a big fee could be assessed.  

Loads are usually listed in the “Shareholder Fees” section of a fund’s prospectus.

Other Costs

There is a spectrum of additional costs that may be even more difficult to spot. For example, a fund that charges a 12b-1 fee may be charging the costs of marketing the fund back to its investors; or a redemption fee may be charged to you if you buy and then sell a fund within the plan very quickly. The list of other expenses could also include account fees for small accounts, exchange fees for switching funds within the same group or kickbacks between the fund company and the plan administrator. 

These fees are usually – but not always – included in the “Shareholder Fees” section of the prospectus.

One resource that can do a lot of this fact-finding for you is BrightScope.com, which has rated more than 30,000 401(k) plans on a number of criteria, including expenses. You can compare your plan to other plans in your industry.

There are very few things that you as an investor can actually control, but you can definitely influence costs. But before you can make changes you have to know what you are paying. Finding out may take some effort but the end result may change your attitude about your 401(k) and the future direction of your investing.