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These 4 Mistakes Will Foul Up Your 401(k)

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Nobody's too happy with 401(k) plans these days. But they're one of the best tools you have to build up the biggest retirement nest egg you can, so it's crucial to use them to your best advantage and avoid making unnecessary mistakes.

Taking the criticism
401(k) plans have been under a lot of pressure since the bear market began. The nearly 40% drop in the stock market during 2008 did a lot of damage to most workers' 401(k) accounts, making many question whether it makes sense to force workers to bear the entire risk burden of bad investment returns. In addition, high fees, lousy investment choices, and the decision of many employers, including Honeywell International (NYSE: HON  ) and American Express (NYSE: AXP  ) , to suspend or reduce their own contributions to their employees' 401(k) accounts haven't given workers any help.

Nevertheless, if you can work around your plan's shortcomings, a 401(k) can still give your retirement savings a big boost. With contribution limits more than three times more than what you can legally put aside in an IRA, 401(k)s can give dedicated savers a much larger nest egg.

So with that in mind, let's take a look at some of the mistakes people make with their 401(k) plans, and how you can avoid them.

1. Not making big enough 401(k) contributions.
Believe it or not, a huge number of workers never bother contributing to their 401(k) plans at all. According to a recent report from Vanguard, just over 30% of workers who are eligible for a 401(k) plan don't bother participating. Although new features like automatic enrollment aim to reduce that number, it will likely never go away entirely -- and not participating at all usually costs you in the long run.

In fact, if your employer still matches part of your contributions, you should generally make sure to contribute at least enough to claim every penny your employer is offering you. That employer money comes with no risk whatsoever; it's essentially free money that can make a huge difference to your long-term returns.

2. Taking money out of your 401(k).
When workers leave a job, they have the opportunity to take whatever they've saved in their 401(k) account with them. Unfortunately, many people make the wrong choice by not rolling that money over into an IRA or their 401(k) at their next job. Withdrawing that money not only forces you to pay income tax and a 10% early-withdrawal penalty; it also permanently reduces how much you have saved for retirement.

Even taking a loan from a 401(k) is often a bad idea. You miss out on investing the money you've taken out, and if you change jobs, you usually have to pay the loan back immediately, or else it is treated as a taxable distribution.

3. Betting the farm on company stock.
Many employers offer employees the chance to own company stock in their 401(k). Often, though, workers go too far with that opportunity. Check out some examples:

Company

% of 401(k) Assets Invested in Company Stock

Pepsico (NYSE: PEP  )

34%

Chesapeake Energy (NYSE: CHK  )

61%

US Bancorp (NYSE: USB  )

37%

Source: Brightscope.

With most 401(k) investment options involving mutual funds, company stock is just about the only way to create a dangerously concentrated portfolio in a 401(k). Keeping your company stock holdings to 10% or less gives you a lot less exposure in case your company hits unexpected turbulence, putting not just your shares but also your job income at risk.

4. Taking the wrong amount of risk.
Employees make mistakes on both sides of the risk spectrum. Young workers often invest in ultra-safe choices like money-market funds that have no growth potential at all. Conversely, older workers often have too much money in aggressive funds that own stocks that are more volatile to the market, such as CapitalSource (NYSE: CSE  ) or Suntech Power Holdings (NYSE: STP  ) -- not bad companies, but ones that might not be the top choice for conservative portfolios.

Many workers never bother changing their investment allocations over time. Only after an experience like 2008's market panic do they realize that they've taken on more risk than they should have. Keep on top of your investments and make sure you're prepared for whatever comes.

Making your 401(k) work for you
Sure, 401(k) plans require some effort from you. But with that responsibility comes the ability to make incredibly valuable decisions on your own behalf. Use your 401(k) Foolishly, and it will help you reach all your financial goals.

Don't have a 401(k)? That doesn't mean you can retire happy. Find out how in this classic article from Fool contributor Mary Dalrymple.

Fool contributor Dan Caplinger has made plenty of mistakes but learns from every one of them. He owns shares of Chesapeake Energy. Suntech Power Holdings is a Motley Fool Rule Breakers pick. American Express and Chesapeake Energy are Inside Value recommendations. Pepsico is an Income Investor recommendation. The Fool owns shares of Chesapeake Energy and CapitalSource and formerly owned shares of American Express. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy plays fair and never cries foul.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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