Three 401k Mistakes to Avoid

Money magazine lists three 401k mistakes to avoid as follows:

• Loading up on company stock
• Being too conservative
• Doin' the smorgasbord thing

My thoughts on these:

1. This one can be hard to avoid. Many company's do their match in company stock (or at least they used to -- I had one that did years ago), so it's hard to keep a balanced portfolio. I used to regularly sell my stock and reinvest it in something else once the grace period was over.

2. It's hard to believe that so many people simply let most of their retirement money sit in money market accounts or in bond funds, but it's true. The 401k is still a good deal for these people because they earn a great return simply by having their contributions matched, but they forego a TON of extra earnings by being so conservative. If anything, my problem is the opposite -- being too aggressive.

3. I was never really a "spread out investments with a little in each option" sort of guy. Maybe it was because when I started I just didn't have that much to spread around, so I picked the three or fours stock funds I liked and then stuck with those.

Money goes on to compare wimpy (too many bonds), unbalanced (too much company stock), and just right (mostly stock funds) 401k investment strategies over a 35-year period. They assume that you start at age 30 with a $50,000 balance and contribute 10% of a $50,000 salary that grows at 1.5% above inflation each year. They don't mention if a match is taken into account or not, so we're left in the dark on that one (nor do they mention the rates of return), but here's what they say each sort of investment strategy will yield after 35 years:

• Wimpy Portfolio -- $474,000
• Unbalanced Portfolio -- $713,000
• Just Right Portfolio -- $973,000

Big difference, huh? Just look how much money those "invest in bonds and money market accounts" people are leaving on the table -- half a million dollars!!!!

Comments

[Pinyo]

Great post. I have 20% in US Large cap, 20% in US Mid cap, 20% in US small cap, 30% international, 5% REIT, and 5% company stock. I am just curious about what you do for yours. Can you share?

[FMF]

I currently have my 401k investments going into three Fidelity funds -- two domestic index funds and one international fund.

[Jake]

That Money article loses alot of credibility when they seem to assume that a particular company stock would underperform a diversified portfolio. The reason you don't go company-stock heavy is not because you want to increase returns, but because you want to decrease risk.

[Mrs. Micah]

Hmm. I had wondered why people ended up with so much company stock. But if the company gave it to them and they were too lazy/faithful to change it...that makes sense. I'm not sure how my company does its contribution yet, but I'll be sure to look out for company stock and limits. Thanks.

Having a lot of company stock is financially unwise, I know, because you already depend on the company for your salary. I plan not to have any.

[Anon]

To minimize taxes and maximize savings for a given asset allocation, you have to use retirement vs. taxable accounts correctly. To the extent possible while achieving your chosen asset allocation, fixed income investments should go in your retirement account, and stocks in your taxable account (buy and hold passive, tax-efficient, low cost index funds, and don't trade). Be as aggressive as you want in terms of equity percentage using your taxable accounts, but it is silly to increase your taxes eventually by having your capital gains taxed at the much higher ordinary income rates which is what happens when you hold your stocks in your retirment plan. For further explanation, see the excellent book and AAII articles by Professor William Reichenstein of Baylor University