035 – Top Ten 401(k) Pitfalls You Should Avoid

1. 1. Not contributing anything to your 401(k)

If your company offers a 401(k) plan with a match, and you are not contributing to the plan than free money is left sitting on the table.  Let’s say, for example; you make $50,000, and the company matches up to 6% of your salary.  If you are not contributing to the 401(k), then you are leaving $3000 ($50,000 x 6%) of FREE money on the table.  Picture a bag of money sitting on the table for you.  Do you want it for free or do you want just to leave it sitting there and go on your way?  I know the answer and so do you.  If you are unsure of the matching percentage in your employer’s plan, go to the Summary Plan Description (SPD) to find out.  If you do not have a copy ask human resources, they will provide a copy for you.

2. 2. Only saving up to the employer match

Congratulations, you are saving enough in your 401(k) plan to receive the match.  Contrary to popular opinion, this is not a retirement plan.  A vast majority are saving just enough money to get that free money.  Instead, calculate your retirement needs and save based off of your comprehensive plan that includes everything that is financially important to you.  For most people, just saving enough to get the company match will not be sufficient, and they will end up outliving their money.  A good rule of thumb is to save at least 15% of your gross income, and that is what I teach anyone serious about saving for retirement.  However, if you are older and have not saved adequately, chances are you may have to save 20% or more in your retirement accounts.

3. 3. Not knowing the total operating expenses in your 401(k) plan.

Controlling the stock market is not possible, but expenses are something you can control.  Unfortunately, not all 401(k) plans are created equal.  Usually, smaller companies get hit with more fees because the total amount of money in the plan is low.  Larger companies with 401(k) plans tend to have fewer fees.  The only way to find out about the 401(k) fees is to take a peek under the hood.  Keep in mind that expenses come in many ways, shapes and forms and there are times we do not dig deep enough.  Most of us look at the fund expense ratios and believe those are the only fees in the plan.  However, the day-to-day operation of a 401(k) plan involves fees for core administrative services–such as plan record keeping, accounting, legal and trustee services.  Thankfully, the government has made the total fees more transparent in recent years.  The first place to find out what your total expenses are in the plan is your annual fee discourse statement, but these disclosure statements are not always uniform from 401(k) to 401(k), and some do not list these administrative expenses at all.  If you can’t find what you need in your fee disclosure statement, go to your human resource or employee benefits department and asking for a breakdown of the fees you are paying. You can also call your plan’s record keeper.

4. 4. Asking your co-workers to pick your investments

I wish there were a stat for the percentage of workers that lean over to the cubicle next to them and ask which funds in the 401(k) to pick.  Selecting investments is not a light decision.  Your investment mix depends on some factors that are most likely much different than the person next to you.  Everyone has a unique blend of emotional risk tolerance, risk capacity, and dreams which determine the overall risk measure in each portfolio.  Get professional help determining your risk and goal factors so you can get dialed into the mix that is best for you.  I do have one warning for you, getting professional help from the investment advisor watching over the plan may not be in your best interest.  Sometimes, these consultants are paid higher commissions or kickbacks depending on which funds you are selected so be careful when getting advice from these people.  Seek out an independent fee-only Certified Financial Planner™ practitioner that can act in your best interest for advice.

5. 5. Not making sure your portfolio is diversified

One drawback from 401(k)’s is that the investment choices are limited.  Often, there may only be 20 or less total options.  Constructing a complex, diversified portfolio of companies, sectors and countries within a 401(k) plan can present a challenge.  Furthermore, tilting the portfolio to higher expected returns such as value, size, and profitability can be impossible.  The more we can diversify the portfolio, the more we can reduce risk.  All things being equal the portfolio with the same expected return but lower risk (standard deviation) percentage should yield more money in the long run.  Practicing modern portfolio theory to build the most efficient portfolio within your plan is in your best interest.

6. 6. Not reviewing your plan

Our risk capacity, tolerance, and goals change over time.  We need to review our investments on a yearly basis to ensure the portfolio fits our measurements.  You must review your overall comprehensive lifestyle financial plan every year with a professional to keep on track.  It is easy to get off your intended track with our lives changing each year.  When you have an objective, third-party professional to help keep you on track, it helps create a situation to put you in the best position to accomplish everything financially you want in life.

7. 7. Avoiding risk entirely

I see this all the time.  So many people do not completely understand risk as it relates to investing, so they end up putting all of their 401(k) money in a stable investment fund.  There are two major problems with this scenario.  First, if we want to live out our retirement dreams, we need some growth in our investments.  Risk-averse individuals do not need to take an enormous amount of risk to generate returns that will help keep them on track.  Second, people who are investing in a stable value fund that may earn only 1% are taking on a tremendous amount of risk.  The risk I am referring to is inflation risk.  If long term inflation is 3% and the investment is only making 1%, then the real purchasing power of the money in the investment is losing 2% every year.  I don’t know about you, but I do not want a guaranteed loss of 2% per year for my investments.

8. 8. Bowering from your 401(k)

Never do this, please.  401(k) loans sound like a deal compared to other loans – I borrow my money for a low-interest rate and then just pay myself back.  But, your retirement money should not be treated as a bank.  First, all the money you borrow is now not invested in the market.  Average market like returns gives us the growth to live out our dreams.  If you are not invested in the market because of a 401(k) loan, then you cannot participate in these average rates of returns.  Second, if you leave your job and still have the loan, you may be forced to pay it all back immediately.  The only way for you to pay it back might be to take a withdrawal from the 401(k), and that means taxes and penalties.  Please, never do this.

9. 9. Market timing with your 401(k)

Emotions are very real and very dangerous, and it’s hard to be objective about your money.  The media does not have your best interest in mind, and they do not take a long-term perspective on money.  It is easy to read or hear about the market may be heading for a recession or other dangerous events that lead us to make emotional decisions.  Your 401(k) is long term money, do not make a short term decision about your long term money.  The best way to get market-like returns is not to fool with your investment mix.  If you do, the probability of achieving your financial goals will most likely go down. Predicting where the stock market is headed and making decisions off of the prediction is a fool’s game.  It requires a crystal ball – and no one has a crystal ball.  Be disciplined.

10. 10. Making a wrong decision when you leave your job

Let’s face it; we are in a different era than our parents.  The average individual will have several jobs throughout their career.  So many people cash in their 401(k) after leaving a job.  People rationalize that it is only a few thousand dollars so the taxes and penalties will not be too much.  However, think of the time value of that money.  A 27-year-old with $3000 in a 401(k) and retiring at full retirement age (67) is giving up way more than $3000.  If we project an average 9% per year over the 40 years before retirement, it comes out to over $65,000 when the $3000 might be more like $2000 or less after taxes and penalties.  I hope you enjoy the $2000.  I prefer the $65,000.