Ultimately, be that day near or far, those of us who work will retire. When we do, we must ensure we will have the resources we need to survive for the rest of our days. One way to ensure we have those assets is to avoid any self-inflicted errors in the way we handle our 401(k) plans.
Here are 10 ways we often mismanage our 401(k) plans. Any one of these mistakes 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 2003 82.2% of eligible employees held balances in their 401(k) plans. For various reasons, then, 17.8% 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 our savings. By not contributing enough to receive the maximum possible match from our employers, we leave money on the table. The potential compounding on those forgone matching contributions can easily amount to thousands of lost dollars in retirement.
3. Using a 401(k) plan as a piggy bank. Many plans today offer a loan feature. While there may be some emergency situations in which borrowing from a 401(k) may be appropriate, as a rule such loans will serve only to reduce the balance that would have been available in the plan at retirement had the loan not been taken. The lost compounding on the loaned dollars while they remain out of the 401(k) account takes its toll. To add to that woe, normal 401(k) contributions are frequently curtailed while that loan is being repaid. Those lost savings dollars also reduce the available funds at retirement.
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/fund to another as they anticipate changes in the marketplace by chasing the latest "hot" investment sector. This is called market timing. Even the pros can't time the market with any consistent degree of success. Thus, it's folly to think we can. As long-term investors, we should be consistent and stick with an investment allocation plan that we find appropriate for our own individual comfort.
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, short-term risk in the equities market becomes more important. It could mean that at retirement 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 cashing out 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. As a rule of thumb, 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, 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. As a rule of thumb, we should try to have no more than 15% to 25% of plan assets in our company's stock. That way we can avoid a total meltdown of our retirement assets like that experienced of late by other unfortunate employees. For vivid examples, think of the lost share values of companies such as Enron and WorldCom before their collapse. Then think of all their employees who held a large percentage of their 401(k) plans in those shares.
8. Failure to allocate or rebalance. Investing is a personal issue, and each of us must establish an asset allocation among 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/being guilty of investment inertia. 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 consistent low returns. Others may make initial investment selections but then go on autopilot by never changing those choices even after those investments head south forever. Both approaches ensure fewer funds will be available at retirement than would otherwise be the case had the participants taken an active interest in how their 401(k) accounts were invested.
10. Keeping the money during a job change. A recent study by Hewitt Associates revealed that 50% of plan participants ages 20 to 29 who changed jobs in 2003 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. How utterly (f)oolish! Cashing out a 401(k) plan when changing jobs means you lose not only the time it took to save those dollars, but that money is also taxed and a penalty of 10% is imposed on the taxable portion of that distribution. When changing jobs, make a tax-free rollover of 401(k) money instead.
The above list outlines the most common missteps we can make as we save for retirement. As Fools, we should be aware of those pitfalls so we can avoid them.
Dave Braze, who answers questions for subscribers to the Rule Your Retirement newsletter service, 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, too. The Motley Fool is investors writing for investors .
