Investors are furious about their 401(k)s. Account balances have shrunk. At Congressional hearings, experts complained that 401(k) costs are too high. Some witnesses called for substantial changes.

Should 401(k)s be abandoned altogether? Hardly. While nearly all plan participants lost something in the downturn last fall, the retirement system has proved to be resilient. Many employers have been taking steps that will strengthen plans in the future.

According to benefits consultant Hewitt Associates, the average 401(k) balance dropped from $79,000 in 2007 to $68,000 in November 2008, a 14% decline. In contrast, the

S&P 500

lost 37.7% during the first 11 months of last year.

Mutual fund companies and employers helped limit the 401(k) damage by encouraging plan participants to stay the course, investing in bonds and other diversified holdings as the stock market tumbled. According to Hewitt, most plan participants now hold broad mixes of stocks and bonds.

The average account had 53.8% of assets in stocks in 2008, with the rest in fixed income. Conservative bond funds protected investors, who were fortunate that their allocation to equities had dropped in recent years, falling from 74.2% at the height of the bull market in 2000.

Part of the shift from equities can be traced to changes in the policies of employers. In the past, many gave company stock to 401(k) participants. The stock often came as matching contributions, and some plans required employees to keep their employers' shares. Companies figured that stock ownership motivated employees and helped to stabilize share prices.

For years, critics warned about the dangers of concentrating on company stock, arguing that savers should diversify and not rely heavily on any one holding. Proponents of diversification received a boost in 2001 when 401(k) participants at Enron lost $1 billion in company stock and saw their accounts wiped out.

In the wake of the Enron disaster, many companies began altering their rules, allowing employees to hold broad-based equity funds instead of company stock. According to a study of 11 million plan participants by fund giant Fidelity Investments, company stock accounted for 10% of total assets in 2008, down from 20% in 2000. Only 16% of participants had all their assets in equities and equity funds, down from 37% in 2000.

Besides changing policies on company stock, many employers have sought to ensure diversification by the introduction of retirement-date funds. These funds are balanced portfolios of stocks and bonds.

In a typical arrangement, a fund company offers a series of portfolios with different target dates, such as 2010, 2020 and so on. Plan participants select funds with targets that are near their retirement dates.

After investing in the funds, the employees need not make any other decisions. The portfolio manager maintains proper diversification, rebalancing the mix of stocks and bonds. As the target date approaches, the fund automatically shifts assets to fixed income, protecting retirees from big losses they could not afford.

In 2008, target funds with maturity dates ranging from 2015 to 2029 lost an average of 30.3%, outdoing the

S&P 500

by about 7 percentage points, according to Morningstar. Funds that dropped less than 25% included

American Century Livestrong 2015

(ARFIX)

,

Federated Target 2015

(FTOSX)

and

Vanguard Target Retirement 2015

(VTXVX) - Get Report

. That was a painful showing, but savers in those funds have enough time to recover from their losses.

In contrast, many holders of company stock lost more than 70% last year.

Besides aiming to maintain diversification, employers have sought to make sure that employees set aside savings in good times and bad. For years, millions of employees have refused to save at all -- or have stopped making contributions when job security looked shaky.

But lately, participation has proved steadier than expected. During the first 10 months of 2008, only 3% of 401(k) participants stopped contributing to their plans, according to the Investment Company Institute, a mutual fund trade group.

Companies have aimed to improve participation rates by using automatic enrollment. Under standard procedures, an employee must fill out forms to have money withheld from paychecks and deposited into a 401(k) account. But with automatic enrollment, the cash is invested immediately -- unless the employee takes action, requesting forms and signing documents.

In a study, Hewitt found that 90% of employees participate in automatic enrollment plans, compared to 68% in conventional systems. In 2008, 16% of employers used automatic enrolment, up from 11% the year before.

To make sure employees manage their retirement accounts soundly, some companies combine automatic enrollment with target-date funds. That way, employees automatically have their savings deposited into diversified portfolios. By taking advantage of the new plan features, 401(k) participants can build accounts that will survive downturns and grow when bull markets return.

Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.