Avoid These Critical 401(k) Investing Errors
BY: Daniel M. Savage
Your employer’s retirement plan is a valuable fringe benefit. It will likely be your primary source of retirement income security years down the road; therefore, avoiding certain fundamental investment errors is a must. Here are eight for your consideration.
1. Not understanding your tolerance for risk.
Defining an acceptable level of risk is the appropriate starting point for every investor. It will allow you to answer two important questions: 1) How much risk am I willing to accept? and 2) How much risk should I accept? The answers will enable you to make wise decisions and stay the course, when appropriate.
2. Ignoring asset allocation when making investment decisions.
Asset allocation is your chosen mix of stocks, bonds, and cash. It profoundly affects portfolio volatility as well as long-term return potential, so it should be age and situation appropriate...and...harmonize with your tolerance for risk.
3. Excessive investment changes.
Some 401(k) participants obsess over market fluctuations and “tips” from friends, causing them to frequently change asset allocations and/or individual investment choices in response. This practice may increase overall expenses while negatively affecting investment performance. For long-term investors, “steady as she goes” may be a better approach.
4. Not considering other assets in one’s household.
Many individuals own investments outside of their 401(k) account, a situation that may apply to their spouses as well. Often these holdings are significant. Taking all household assets into consideration will generally lead to sounder investment decisions.
5. Maxing contributions to a poor plan.
The sad truth is that some 401(k) plans are just plain awful in terms of expenses and/or subpar investment options. A participant may be better off by diverting some contributions to an IRA in which he or she is able to invest in lower cost, high-quality investment options. NOTE: Don’t overlook the employer matching contribution, and be sure to confer with your Wealth Manager and tax preparer before making this decision.
6. Ignoring special (outlier) financial circumstances.
Some participants enjoy special circumstances. For example, a participant and/or spouse may be covered by a classic pension plan that will pay a substantial portion of living expenses during retirement. This may allow the participant to take a less conservative approach to investing than would otherwise be the case.
7. Avoiding lesser known funds.
Retirement plans typically feature funds from well-known companies such as Vanguard, Fidelity, T. Rowe Price, American Funds, and more. Plans may also include less-familiar names. Rather than rejecting them out of hand, look closer because of possibly lower fees and/or excellent quality. Morningstar reports and a conversation with your Wealth Manager are good information sources.
8. Not deferring a sufficient percentage of compensation.
Of course, this is a very subjective notion, but countless studies show that participants often invest well below their financial capacity even when a company match is available. Over time, this may result in hundreds of thousands of dollars of lost retirement assets. Re-examine your household budget and consider a formal retirement planning exercise.
Many more mistakes are possible, including but not limited to borrowing from one’s account, cashing out when changing jobs, not keeping up with contribution limits, and ignoring the Roth option. We’ll address them in a future article.
There are no guarantees with investments, but avoiding the major mistakes discussed here will improve your odds for a successful retirement and provide considerable peace of mind along the way. Please feel free to contact one of our Professional Wealth Managers to learn more.
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