What should I do now? It’s a natural question for retirement investors watching the unfolding Wall Street financial crisis and worrying about their portfolios.

For most retirement investors, the best answer is: Do nothing. The collapse of venerable companies like Lehman Brothers and A.I.G. is frightening indeed. But this isn’t the time for the small investor to make big moves.

“I think the small investor usually does exactly the wrong thing for understandable reasons,” says Philip Cooley, a professor of finance at Trinity University, San Antonio, TX, and an expert on retirement withdrawal strategies. “They sell low and they buy high, and that is driven by fear, hope and greed. Fear drives you from the market when we experience what we’ve seen this past week, and when prices get high, euphoria sets in. Even if you understand the emotions and how they impact you, it’s difficult to overcome.”

So, let’s take a break from the epic popping of the housing/sub-prime loan bubble and focus on the fundamentals for long-term retirement saving.

–Take a deep breath. The collapse of major financial players naturally generates fear about who might be next to fail. But remember to draw the distinction between the fate of companies and your personal accounts. Any funds you keep at a bank are insured by the Federal Deposit Insurance Corp. (FDIC), up to $100,000 at a single financial institution per investor.

Brokerage accounts do not enjoy similar insurance protection. However, strict Securities and Exchange Commission rules do require brokerage firms to segregate customer accounts from their own money. In the event that a brokerage firm defaults, investor assets shouldn’t be in jeopardy; typically, the customer accounts will be transferred to another brokerage firm through a merger or sale.

If that fails, a federally mandated non-profit corporation called the federal Securities Investor Protection Corp. (SIPC) steps in to protect investor accounts.

It’s important to understand that the SIPC doesn’t protect you against market losses or fluctuations; it’s there to make sure you don’t lose the underlying assets, such as stocks, bonds or shares of mutual funds.

–Don’t try to time the market. Investors never win by trying to time economic and market cycles. “You need to be right twice, and that’s incredibly difficult to do,” says Cooley. “The turnaround this time certainly will sparked by solid evidence of a turnaround in the housing market–and that’s going to be very difficult to call.”

If you make regular contributions to your retirement account via automatic payroll deduction or some other method, keep going. You’ll benefit from today’s lower prices and the eventual market recovery.

Also, use the market decline to take stock of your portfolio, and to make sure your investment mix is appropriate for your target retirement age. Most investment experts recommend staying about 90 percent in equities until you reach your early 50s; at that point, scale back to 70 percent. Gradually adjust downward to 50 percent in your early 60s, moving more money into fixed income investments.

–Don’t hold individual stocks. It’s easy to look like a genius stock picker in a bull market, but that illusion can disappear quickly when the market heads south. Recognize that stock picking is a professional occupation requiring financial knowledge and willingness to spend a lot of time monitoring your investments. For most of us, it’s just too risky.

Instead, keep things simple by putting your 401(k) or IRA funds into straightforward mutual fund investments. My favorite choice is lifecycle–or target date–mutual funds. Here, you don’t even need to sort through the fund options in your employer’s plan; instead, you just pick a fund targeted for the year you expect to retire, and the fund manager adjusts the asset mix as your target year approaches.

Cooley advises a fairly conservative balance between stocks and bonds. “Unless you are extremely risk averse, I’d have 50 percent in well-diversified mutual funds holding common stocks, and the rest in bonds and cash.”

–Have a buffer. Cooley recommends planning for retirement with three to five years of living expenses in cash and bonds with laddered (or varying) maturity rates. “Events similar to what we’ve just seen have occurred many times in our history. If you have a buffer, your portfolio of common stocks can gyrate around on the side, and you’ll be able to sleep at night.”

The best way to build that buffer is to fine-tune your household budget with an eye toward cutting expenses. Keep an eye on interest rates in the months ahead; some experts see lower rates later this year in the wake of the Wall Street crisis; if that happens, you might have the opportunity to refinance your mortgage and other consumer debt expenses.

At the same time, look for ways to reduce regular expenses like telephone and mobile bills, cable TV, restaurant tabs and the like. You might be amazed what you can achieve with some careful budget scrutiny.

In a shaky economy, cash is king, so do your best to hang on to some of it.

Tags | 401(k), IRA, planning