A 401(k) plan can be an integral part of anyone's retirement savings strategy, but many investors make mistakes that could prevent them from achieving financial security in their golden years. Read on to learn whether you're making these three common mistakes with your 401(k) plan.
1. Investing too little
Many employees pick their 401(k) contribution rate when they establish their 401(k) account and then never adjust it. Since many workers might be setting up those accounts when they're young and strapped for cash, that could be a big mistake. One good strategy to fix this common error is to increase your contribution percentage by 1% annually until you're making the maximum contribution allowed under your plan. That extra 1% per year is not likely to derail your monthly budget -- especially if you receive yearly raises to keep up with your cost of living -- but thanks to compound interest, it could have a big positive impact on your future retirement savings.
Another important consideration is whether or not your employer matches your contributions and, if so, up to what percentage of your salary. If there is a match, try to contribute enough to take full advantage of it -- immediately, if possible. After all, that's free money.
2. Setting and forgetting -- the wrong way
Too many investors try to pick yesterday's top-performing stocks or concentrate their portfolio too much around one particular type of investment -- and then never make any changes. According to one TIAA-CREF study, Americans are more likely to spend at least two hours choosing a restaurant for a special event than they are to spend that amount of time preparing an IRA investment.
Avoid making that mistake by setting aside enough time to evaluate your 401(k) options. Since it's been proven time and time again that investing for the long haul outperforms short-term trading, spend less time chasing current fads and more time researching quality businesses that can provide solid returns through thick and thin.
If you find picking individual stocks too daunting, don't worry. Most plans offer plenty of high-quality index funds, including funds that focus on big companies, mid-sized companies, and small companies. Diversifying across such equity index funds can help balance your returns over time. Further, if you're worried about the risk that the economy could dent your nest egg, you can take solace in knowing that since 1945 the average contraction phase of the U.S. economy has lasted about one year, while the average expansion phase has lasted almost five years. That suggests that over a lifetime, investors might be better served worrying less about the economy and more about how to boost their 401(k) plan contributions.
3. Procrastination nation
According to the Federal Reserve, nearly half of Americans have not saved a dime for retirement. That's a big mistake, because it means millions of people will rely on Social Security for all of their retirement income -- and that's not good. In 2013, the average Social Security payment totaled just $1,300 per month, or $15,600 per year. On top of that, Social Security benefits may eventually be cut in order to keep the program solvent.
If you'd like to live comfortably in your golden years, the best way to increase your retirement income is to start investing as soon as possible. The median household income in the U.S. is around $52,000. If a person earning that amount annually contributes 10% ($5,200) per year to a 401(k) plan and earns a 6.5% return for 30 years, their portfolio will be worth $478,000 in the end. However, if that same person only invests for 15 years, their retirement account will only reach $134,000 -- that's 72% less, and it's not nearly enough to fund a long and financially secure retirement. If you don't have 30 years until retirement, then it's more important than ever to get started and invest as much as you can.
One more thing
According to the Employee Benefit Research Institute, 82% of Americans aren't confident about their financial security in retirement. If you're one of them, then investing your 401(k) plan's maximum amount, spending more time researching your investment options, and getting started immediately might change that.