For most people, their 401k plan will represent their second largest asset after their home, and, most certainly, their largest retirement savings tool. Unfortunately, those very same people will likely spend more time planning their vacations or researching their next vehicle purchase, than they will planning for their retirement and managing their investments.
Here Are 5.5 Mistakes People Will Make with Their 401k Plans and How You Can Avoid Them.
1. Not Putting in Enough to Get the Full Match
There is nothing better than FREE MONEY. Are you taking yours? The majority of the 401k plans that we see will typically offer something along the lines of a dollar for dollar match on the first 3% of your salary, or 50 cents on the dollar match on the first 6%. At the very least, contribute enough to get the full match.
2. Picking Funds Based on Performance, Not on Allocations
The XYZ mutual fund earned 30% last year, WOW, must be a great investment, right? Perhaps. But picking funds based strictly on performance is like buying the car with the best gas mileage, or fastest 0-60, without regards to whether you actually need it or not, or if it is appropriate for you and your family. Most of all, the same asset class will seldom be the top performer every year. Pick investments to your asset allocation, not performance.
3. Not Rebalancing
You do not make money until you sell. Think of your home. Does it matter how much it is worth unless you plan on selling it? Same with investments, unfortunately you cannot live in your mutual funds. A balanced and properly allocated portfolio will have certain investments that outperform others over the 3 month t0 12 month periods. Buy Low, Sell High. Lock in those gains and reinvest in under-performing allocations.
4. Not Identifying If a Roth 401k Option is Available
Any money you put into a 401k plan now, you will get a tax deduction now, and you will be paying taxes on that money in the future as you take it out. If you have done a great job saving, those taxes may represent a huge bite. A Roth contribution will not earn you a tax deduction now, but may mean tax free earnings in the future. If you expect your income to be higher in the future than it is now, a Roth option may be your best choice.
5. Picking a Life Cycle or Target Date Funds Without Looking Under The Hood
These types of funds are now very common in retirement plans, and in many cases are your default investment allocation. Most mutual fund companies such as Fidelity, BlackRock and Vanguard will have their take on them, however they are all quite different. You cannot simply pick the fund that matches you closest retirement date. You have to look at the underlying allocation and adjust and select the portfolio that best matches your investment goals and risk tolerance.
5.5. No Allocation to Dry Powder
Buy LOW, Sell HIGH. At least once a year, the markets will sell off and present opportunities to buy good investments at lower prices, much like we have seen in the first quarter of 2016 where there markets fell nearly 15% and then to quickly rebound.