Four Common 401(k) Mistakes to Avoid
While there is no one-size-fits-all, avoiding these mistakes is a good start
A lot of plan participants make the same mistakes when choosing investments. The results are low returns and unbalanced portfolios. Avoiding these four mistakes is a good start for getting more out of your 401(k).
There is no easy answer to how you should allocate your 401(k). You have to make these decisions on your own based on your personal risk tolerance, investment choices, and the allocation of your other investments.
Mistake #1: Going Overboard on Risk Avoidance
Many participants are either overwhelmed by the list of investment choices or are simply afraid to take any risk in their investments, and put all of their savings into a money market or stable value fund. Money market and stable value funds are basically low risk, low return investments. Most participants have a long investment horizon and can tolerate some volatility to get the higher returns later.
Mistake #2: The Equal Allocation Trap
Another common mistake is investing an equal portion into each available investment option. There are many problems with taking this approach. First, you do not need to invest in every option available in your plan, nor do you need to invest in every bond and every stock fund to achieve diversification. Each investment option has been selected based in its individual characteristics, not based on how all of the options work together.
Mistake #3: Too Much Company Stock
Many companies allow plan participants to purchase company stock in their retirement plans. As tempting as it might be to bet on a company you know very well (hey, you work there, right?), you should minimize your investment in company stock.
Investments in diversified bond and stock mutual funds will reduce the risk of putting too much of your retirement money into one category. As a rule of thumb, keep your investment in company stock below 10% of the total account.
Mistake #4: Eschewing Small-cap and International Stocks
Most investors are naturally risk-averse, and shy away from investments that have been down. The performance of small-cap and international stocks have been less than domestic large-cap stocks recently, but these funds are still excellent choices for increasing portfolio diversification. They have characteristics that can improve the overall returns and lessen the volatility of your portfolio.
Remember, risk and return are directly related. Don’t rule out investment options based on past performance alone. Consult with your employer’s human resources manager or whoever manages the company’s benefits plan for help choosing the best allocation. Or find a financial advisor who can help you figure out which mix is right for you.