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6 Important 401(k) Mistakes to Avoid

By Barbara A. Friedberg

By now, you’ve heard the drill, invest in your employer’s 401(k) plan, at least in the amount to secure that free-money employer match. After all, where else are you going to receive free cash? You may believe that once you put money into your employer’s 401(k) plan, you’re done. All of your retirement investing is taken care of and you can now sit back and get on with your life. This may not be the case. Like most financial matters, the 401(k) investing is not as simple as it appears on the surface. Further questions can plague the employee when it comes to saving for retirement:
  • Which investments to choose?
  • What percent should I invest in stock funds in comparison with bond funds?
  • Is a target date fund the best option for me?
  • Should I invest all my retirement saving dollars in my workplace 401(k)?
401(k) mistakes are plentiful and painful. Read on to uncover 6 potential 401(k) pitfalls and find out how to avoid them. Get answers to your 401(k) questions here>>>

401(k) Mistake #1: Choosing Investments Based On Past Returns

When choosing mutual funds in which to invest, and easy method is to check out the 1 year, 5 year, and 10 year average annual returns. Then you could look for the fund that outranked during each of those periods. Sounds like the perfect strategy doesn’t it? There’s just one drawback, in most cases, funds that outperformed for one or several years, don’t continue to outperform. Research is clear that the top funds one year are unlikely to persist over the long haul, thus this is not the best way to choose a fund. Take a look at the best performing large-company stock funds over 1, 5 and 10 year periods (Source; Kiplinger.com, data through March 31, 2016): Large-Company Stock Funds with the best 1-year performance records:
Fund Name Symbol 1-Year return 3-Year return 5-Year return 10-Year return Max. Sales Charge Expense Ratio
Federated Strategic Value-Dividend A SVAAC 11.39% 11.41% 12.02% 6.66% 5.50% 1.05%
Integrity Dividend Harvest Fund Class A Shares IDIVX 10.85% 11.08% —— —— 5.00% 0.85%
Polen Growth Inv POLRX 10.44% 15.16% 13.21% —— 2.00% r 1.25%
  Large-Company Stock Funds with the best 5-year performance records:
Fund Name Symbol 1-Year return 3-Year return 5-Year return 10-Year return Max. Sales Charge Expense Ratio
Shelton Capital Nasdaq-100 Index Direct NASDX 4.03% 17.79% 15.18% 10.91% none 0.49%
USAA Nasdaq-100 Index USNQX 04.10% 17.55% 14.58% 10.39% none 0.57%
Smead Value Inv SMVLX -03.56% 10.33% 14.55% ——- none 1.26%
  Large-Company Stock Funds with the best 10-year performance records:
Fund Name Symbol 1-Year return 3-Year return 5-Year return 10-Year return Max. Sales Charge Expense Ratio
Parnassus Endeavor PARWX 01.07% 14.29% 12.93% 11.12% none 0.95%
Alger Spectra A SPECX -02.36% 12.80% 11.50% 10.96% 05.25% 01.19%
USAA Nasdaq-100 Index Direct NASDX 04.03% 17.79% 15.18% 10.91% none 0.49%
Did you notice that winners rarely stay in the lead for long? In fact, no fund was listed in the top 3 large-company stock funds for 1, 5, and 10-year terms. Notice that the only fund that appeared twice, USAA Nasdaq-100 Index Direct, also had the lowest annual fee of 0.49%. Past performance is no way to pick your investments.

401(k) Mistake #2: Avoiding Market Matching Index Funds

You won’t find a vanilla S&P 500 index fund at the head of the queue of top performers. But you may be surprised to find out that according to a recent Morningstar survey, the market-matching index funds tend to outperform the actively managed mutual funds most of the time. In addition to the Morningstar survey, there is an abundance of support for the benefits of passive investing with low fee index funds.

401(k) Mistake #3: Ignoring Fees

“Investors would have substantially improved their odds of success by favoring inexpensive funds, as evidenced by the higher success-ratios of the lowest-cost funds in all but one category.” ~” Morningstar’s Active/Passive Barometer”. Looking to boost your investment returns? One simple method is to choose low fee funds. The highest fee funds tend to have the lowest returns. By choosing low fee index funds you immediately improve returns by up to 1% or more over higher fee funds due to the smaller percentage of money going into the fund manager’s pockets. Be sure to ask your HR department what types of funds are available in your company 401(k), even before you enroll.

401(k) Mistake #4: Not Looking at the Whole Pie

Many investors avoid considering all of their investable assets when choosing investments in their 401(k). If you’re married, then your husband may have investments in his or her 401(k). Additionally, you may have an old IRA or a brokerage account as well. What about the cash portion of your savings? Forget the accounts, where the stocks, bonds, and funds are housed. Look at all of your family’s investments as pieces of one pie. They need to fit in with your risk tolerance and time horizon. Joan and Jim are risk-averse investors in their early 50’s. For their age and time horizon they desire a 65% stock – 35% bond/cash asset allocation. Here’s their actual asset allocation pie:
  • Joan’s 401(k) Assets: $150,000 stock funds
  • Jim’s 401(k) Assets: $100,000 stock funds
  • Bank Long-term Savings Account: $60,000
Together Joan and Jim have $310,000 saved up for retirement. Here’s how their asset allocation pie is divided up:
  • $250,000 stock funds
  • $60,000 fixed/cash assets
That is equivalent to 80% invested in stock funds and 20% in fixed. They are over-invested in stock funds and under-invested in bond/cash investments, according to their age and risk tolerance. Joan and Jim need to buy more bond/fixed investments and sell a portion of their stock funds so that their actual investments match their risk profile.

401(k) Mistake #5: Considering Your 401(k) as Your Own Bank

Many 401(k) providers tout the advantages of borrowing from your own 401(k). There’s reasonable thinking behind this allegation; borrowing from a 401(k) can be a better source of needed cash than maxing out your credit cards or securing a home equity line of credit. That’s because when borrowing from your 401(k) you’re repaying the interest on the loan back into your own account. That said, when you take money out of your 401(k) those dollars aren’t inside the account growing and compounding for your retirement. You’re losing the future value of those borrowed funds. Additionally, in the case of a job loss, you’ll need to repay the borrowed 401(k) monies fairly rapidly. By borrowing from your 401(k), you’re defeating the purpose of this tax advantaged retirement savings opportunity. We have a full breakdown of all of the calculations and reasons behind why we recommend you avoid taking a loan from your 401(k) if at all possible: Why it Doesn’t Make Sense to Take a Loan from Your 401(k).

401(k) Mistake #6: Liquidating Your 401(k) Account When You Switch Jobs

When leaving your job, it’s tempting to take that pool of saved up money out of the company plan without rolling it over into an IRA. In many cases, that large chunk of change can beckon; a new car, a home addition, or a luxury vacation may appear to be a good use of your 401(k). If you cash out your 401(k) when you leave a job, in addition to the loss of future retirement dollars, if you’re under age 59 ½, you’ll also be subject to a 10% penalty along with income tax payments on the amount. That can turn into an extremely costly mistake, for now and later. In sum, your 401(k) can be an excellent retirement savings account. Regular contributions, employer match, long-term compounding, can all add up to a healthy retirement fund. Yet, make a few of these retirement mistakes and you’ll end up sabotaging a potentially successful retirement plan. Employers; If you don’t currently offer a 401(k), what are you waiting for? Image credit: Wikipedia