Retiree Portfolio Ten Common 401(k) Mistakes

Despite the turmoil of recent days, ultimately the market will return to some semblance of normalcy. And someday most working folks will retire, too. To help ensure we retire successfully, we must strive to avoid 10 common errors when managing our 401(k) plan accounts.

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By David Braze (TMF Pixy)
September 24, 2001

Given the events of the past two weeks and the uncertainty of the future, it seems somewhat petty or even selfish to think of our personal finances or our retirement plans. Somehow, what seemed so important a month ago has suddenly fallen off our "to do" lists. Our nation faces a crisis unlike anything it has encountered in the past, and our lives won't be quite the same in the days to come.

Still, if history is any guide at all, life in this country will go on. The nation will survive, and our economy will regain its former strength. While some aspects of our of lives may change, it's a pretty safe bet that most things will stay the same. One aspect that won't change is retirement. Despite the current turmoil, those of us who are employed will retire. In the meantime, we must focus on accumulating enough savings. One way to ensure we have those assets is to avoid errors in the way we handle our 401(k) plans.

Here, then, are 10 ways we often mismanage our 401(k) plans. Each has the potential to cost us thousands of dollars in the amount we will eventually accrue for retirement.

1. Failure to participate at all -- According to the Profit Sharing/401k Council of America (PSCA), in 1999 82.5% of all eligible employees participated in their 401(k) plans. For various reasons, then, 17.5% of all eligible employees failed to contribute one plugged nickel to their plans. It would be nice to think those folks saved for retirement elsewhere. Unfortunately, there is no data to confirm they did. And those who didn't almost certainly face a bleak retirement future.

2. Failure to contribute enough to receive the maximum employer match -- An employer's matching contribution represents free money. It provides an immediate and totally risk-free, tax-deferred return on your savings. By not contributing enough to receive the maximum possible match from your employer, you leave money on the table. Not only do you miss out on that money, but you miss out on the compounded growth that money could have earned -- a loss that could easily amount to thousands of dollars.

3. Borrowing from your 401(k) -- Many plans offer a loan feature. There are some emergency situations in which borrowing from a 401(k) may be appropriate. However, such loans will only serve to reduce the balance that would have been available in the plan at retirement had the loan not been taken. While the loaned money is out of your 401(k) account, it is not growing -- which will ultimately reduce your retirement assets. To learn why, see this detailed discussion.

4. Trying to time the market -- Many plans today offer a 24-hour ability to change investments when desired. Some participants use this feature to switch from one investment to another as they anticipate changes in the marketplace by chasing the latest "hot" sector. This is called market timing. Even the pros can't time the market with any consistent degree of success. Long-term investors should be consistent and stick with an appropriate investment allocation.

5. Being too conservative -- Younger participants tend to have more invested in equities than do older participants. Still, many participants are too conservative for the long haul. History indicates that a larger return is available in stocks, and the risk of loss in the equities market declines over time. Consequently, those with 10 or more years until retirement should be willing to have a high proportion of their investments in equities to ensure the maximum accumulation possible in their 401(k) accounts.

6. Being too aggressive -- As we get closer to retirement, we have to become more aware of short-term risk in the equities market. Otherwise, we may have to cash in our plans when stocks are at a low. In the short term, stocks can and do plunge dramatically. Therefore, to avoid having to sell during one of those drops, we should protect our stash by steadily decreasing our exposure to stocks beginning five to 10 years before we retire. Then, money we know we will take from our plan for living expenses in the next five years should remain out of the stock market.

7. Holding too much company stock -- We may think our employer is the next Microsoft (Nasdaq: MSFT), but banking most of our retirement money on that belief keeps too many eggs in one basket. The business -- and your shares -- could suffer a severe setback. Try to have no more than 15% to 25% of your plan assets in company stock. Otherwise, you may suffer the same fate as the Lucent (NYSE: LU) employee who had to postpone his retirement because was invested 100% in the company's shares, which have dropped almost 95% over the past two years.

8. Failure to allocate or rebalance -- Investing is a personal issue, and each of us must establish an asset allocation of stocks, bonds, and cash that's appropriate for our age, ability to sleep at night, and retirement plans. Once established, we must recognize that over time our investment performance will cause that allocation to change within our portfolio. That means we must rebalance our holdings to re-establish the desired allocation. If we don't do that from time to time (once a year is good), then an imbalance could adversely affect our total accumulation during one of the inevitable gyrations in the marketplace.

9. Keeping a default election -- Many plans today have a default election. That means you must opt out of the plan. If you don't, you're automatically enrolled, and your contribution will be made to a default option, usually an ultraconservative choice such as a money market fund. Some folks allow that automatic election to stand, and thus condemn themselves to low returns. Others make the initial investment selections, but then go on autopilot by never changing those choices even after those investments prove to be bad choices. Both approaches lead to a retirement dead end. 

10. Keeping the money during a job change -- A study last year by Hewitt Associates revealed that 68% of plan participants who changed jobs in 1999 took cash withdrawals from their tax-deferred retirement accounts rather than leaving their money in the plan or rolling their balances into their new employer's plans or into IRAs. Those tax-deferred savings are thus lost forever, and can only mean fewer retirement dollars and higher taxes and penalties. How utterly (f)oolish!

Keeping track of all these points isn't as complicated as it may sound. However, if you think you could use some expert, objective advice about your retirement plan, check out TMF Money Advisor.

See you next week. Until then, post away as usual on the Retirement Investing or Retired Fools boards.

Best to all... Pixy

Dave Braze has more than two decades' worth of financial planning experience, which is amazing considering that he claims to be 29 years old. Of course, he's been claiming that for a couple of decades. The Motley Fool is investors writing for investors.