401(k) Mistakes (also applies to other Retirement Plans!)

As we've discussed on these pages in the past, in these days you're pretty much on your own when it comes to planning for your retirement. Granted, the State of Illinois still has its pension plan, but beyond that, few employers provide anything in terms of retirement benefits beyond the 401(k) or other deferred retirement plan, which means it's up to you! For the purpose of brevity, I'll refer to 401(k) plans throughout this article, but know that most of the information applies to 403(b) plans, 401(a) plans, and 457 plans as well as Keogh, SIMPLE, and SEP IRA plans.

For most of us, the 401(k) is the default to take on the role that the pension plan did for previous generations. Paying attention to and avoiding the following Mistakes can help you to ensure that you have a financially-secure future.

#1 - Choosing Not to Participate
It's amazing how many folks, young or old, don't participate in their company's 401(k) plan. If your employer matches your contributions, you're effectively giving money away. You wouldn't do that with a raise or a tax cut, would you? And even if your employer doesn't match your contributions, the tax savings should be enough to spark your interest... If you're not presently participating in your company-offered 401(k) plan, bear in mind that time is your greatest ally when it comes to building up your savings. Starting early and making regular contributions to your account will have an enormous impact on the results when you're ready to begin using these funds in retirement.

For example, if you put $1000 into your account at age 25, with a compound rate of return of 10%, by age 65 your account would be worth over $45,000. By the same token, if you'd waited until age 30 to make that $1000 deposit, by age 65 it would only have grown to $27,000. That's roughly a 40% difference affected only by waiting for 5 years!

#2 Not Having a Plan
Blindly allocating your investments can have dire consequences, whether you know it or not... I have met folks who believed that they were doing the right thing by "diversifying" across every fund choice in their plan. This results in diversification all right, but doesn't take into account the time horizon for the investment, your own risk tolerance, and other factors.

Another acquaintance, age 26, had a conservative portfolio of investments in his account - amounting to more than 80% in bonds and fixed instruments. At that age, even the most conservative of investment plans should have you above a 50% ratio in equities, in order to take advantage of long-term stock market returns. Granted, stocks are more volatile than bonds and fixed income investments, but with a longer time horizon, bonds and fixed income investments can hardly keep up with inflation, let alone provide any measure of growth. In addition, the longer time horizon provides the time to ride out any "bumps" in the market that may take place.

It makes good sense to analyze your potential investment choices, consider your time horizon, your risk tolerance, and ultimately your investment "mix", in order to create a plan for your investments that will carry you toward that "holy grail" of investment success - a fruitful retirement.

#3 Set It and Forget It
While we shouldn't obsess over every single market move every single day, we also shouldn't make our investment and contribution decisions once and then leave them for 20, 30 or 40 years. Over time, your various investments are going to grow at different rates, eventually causing one or more of your holdings to become overweighted (with regard to your planned "mix").

I generally recommend reviewing your quarterly statements just to see how things are going in your account, and choose one of the quarters to make any rebalancing moves annually. These rebalancing moves don't need to be done until one or another of your investments gets to a 5% or more variance from your plan.

#4 Taking Out a Loan
This falls into the category of things you *can* do but shouldn't. Kinda like jumping off a cliff. What happens here is that your contribution program goes on hold as you pay back the loan, and if you don't pay it back, you'll owe tax and penalties. In addtion to that, you're paying back your tax-deferred fund with after-tax dollars, which will eventually be taxed again when you withdraw the funds at retirement. In only the most extreme of circumstances should you consider this kind of loan - honestly, you'll regret it if you do it.