The 3 Biggest 401(k) Mistakes

News flash: Investors hate to lose money.

While "don't lose money" is a good rule of investing (Warren Buffett counts it as Rule No. 1), people have been known to make some pretty dumb moves to avoid racking up losses in the stock market -- especially in their 401(k)s.

Because 401(k)s are focused on retirement, it's easy to panic when your portfolio starts to see a downturn. Here are three all-too-common mistakes investors make that can end up hurting you.

1. Chasing performance
When choosing funds for your retirement plan, recent rankings can seem like a safe bet -- but focusing on short-term performance can be the kiss of death for your retirement nest egg. Short-term trends can come and go, but long-term performance is much more indicative of a manager's true abilities.

It's also easy to put your money in the hottest sector -- forgetting that if you wait for a sector of the market to run up before you get in, you've probably already missed much of the upside. Chasing hot recent performance is akin to buying high and selling low -- a losing prescription if ever there were one.

For example, over the past five years, the ticket to the top of the performance charts has been mutual funds that invest in commodities and Latin America. Black Rock Global Resources (SSGRX) has posted a 38.5% return during that time, while T. Rowe Price Latin America (PRLAX) has risen by an eye-popping 43.3%. But investors shouldn't assume that these funds will continue to do as well in the future. Odds are, another asset class or group of funds will take center stage for the next five years. Remember the oft-quoted disclosure on mutual fund performance -- past results are not a guarantee of future performance!

Similarly, for most of this year, investors have been chasing commodity plays such as Weatherford (NYSE: WFT  ) , Peabody Energy (NYSE: BTU  ) , and XTO Energy (NYSE: XTO  ) -- each a monster performer in 2007 -- while shunning financials such as Citigroup (NYSE: C  ) and Prudential Financial (NYSE: PRU  ) . But the tide can turn quickly, and yesterday's laggards can easily become tomorrow's outperformers.

Since you can't know when shorter-term trends are going to reverse, the key is finding excellent long-term investments and sticking with them through thick and thin. Picking top managers -- those whose long-term performance outpaces the broader market -- will help you grow your nest egg indefinitely.

Just take Ron Muhlenkamp, the skipper of the embattled Muhlenkamp (MUHLX) fund. Even though the fund has struggled in recent years, in part because of holding on too long to housing stocks such as NVR (NYSE: NVR  ) and Centex (NYSE: CTX  ) , it has a strong long-term track record. Despite its recent troubles, the fund still outranks the vast majority of its large-cap value peers. Shareholders have been jumping ship, but they may be a bit premature in underestimating Ron Muhlenkamp's abilities.

The fund has had stretches of time in the past when its style of investing has been out of favor -- such as in the late 1990s -- but over the long run, it has delivered. I believe the odds are good that these deserters will be kicking themselves in a year or two for not sticking with a great, long-term manager who encountered an inevitable period of short-term underperformance!

2. Trying to play it safe
Watching your investments lose money, especially when it comes to retirement savings, can spur you into "playing it safe" with money market funds and low-yielding bond funds.

But the truth is that nobody ever built a retirement nest egg by investing in money market funds -- because they rarely outperform even the annual interest rate, much less the S&P 500. If long-term growth is your goal, stocks or stock mutual funds should be your investment of choice.

Even investors who have retirement in their immediate sights -- and who are even more inclined to play it safe -- will still need to grow their portfolio for another 20, 30, or more years. Make sure you have enough equity exposure to help your portfolio go the distance.

3. Picking bad, and costly, investments
Unfortunately, not all 401(k)s are created equal. Many contain funds that are expensive, poorly performing, or both -- and it means some participants can end up throwing away more than 2% of their assets every year in management fees and expenses.

But as long as your company provides a match -- and you're contributing enough to take advantage of it -- even mediocre 401(k) choices are better than not participating. You can always invest in an index fund with minimal fees or ask your plan administrator to provide better funds.

Among the choices you have, however, look for high-performing, long-term managers and a low fee structure -- both will keep more money in your portfolio and help you create strong long-term returns.

The Foolish bottom line
No one likes to lose money, so make sure you're not shooting yourself in the foot by making unwise moves in an attempt to avoid losses. Invest for the long run and stick with good managers, and your 401(k) will help you create the retirement you want to enjoy.

If you're not sure how to find the best fund managers, check out the Fool's Champion Funds investment service. We single out the best mutual fund investments around, an invaluable service for 401(k) investors. You can get a special sneak peek at all of our fund picks with a free 30-day trial today. Click here to get started -- there's no obligation to subscribe.

Amanda Kish heads up the Fool's Champion Funds newsletter service. At the time of publication, she did not own any of the companies mentioned herein. Muhlenkamp is a Champion Funds recommendation. Click here to find out more about the Fool's disclosure policy.


Read/Post Comments (3) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 10, 2008, at 11:48 AM, SteveTheInvestor wrote:

    I'm not too sure I agree. About a year ago I started moving money from stock funds into cash (GIC) accounts, with a tiny bit into bonds. I went from 10% cash to almost 60% over the course of several months. I cut my holdings of Dodge & Cox Stock fund (as an example) by 75%. I am SO glad I did. That fund is down over 30% from highs. The S&P is down big too. My 401K on the other hand is down about 6% from its high.

    I'm not a brilliant investor.... just a cautious one. Caution pays and in this kind of market, cash is king. I'm likely to increase my cash levels as things get worse, which they probably will. I don't have a problem being 100% cash if I think it is warranted. I would rather earn 2% a year than lose what I have and have to wait several years to get back to even.

  • Report this Comment On September 10, 2008, at 6:02 PM, jskdy wrote:

    I can't understand why all the money managers INSIST it is better to stay in stocks, etc., and stay away from silver and gold. If we do have more of a recession, (or something worse!), they will always have intrinsic value. I have been investing in silver since it was $6/oz. Now it is at $17, at least that is what it is selling at now, and it is probably WORTH more. I think they manipulate the market, so people will not cash out their accounts. If we move our paper dollars out of their hands, what will THEY do for a living? Oh, not to worry! THEY have probably invested n gold. ;)

  • Report this Comment On September 11, 2008, at 11:28 AM, GMSInvesting wrote:

    Talking about intrinsic value, do you really believe silver has an intrinsic value of $17 dollars if everyone needed to liquidate? Who would a pile of silver really be worth $17/oz to? The only way someone would buy it like that would be to speculate or to add value to it. If its a corporation that can add value and make a return from buying the silver at that price then you should probably be invested in them to. If not, your silver holdings are probably over valued.

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