Big 401k Mistakes

The Wall Street Journal lists four big 401k mistakes as follows:

1. Under- or over- contributing

2. Ignoring fees

3. Taking a 401(k) loan to pay off debt

4. Ignoring allocation

My thoughts on these:

1. I've been contributing the max to my 401k for years. But I've also been saving in non-401k accounts as well. The best bet is to at least cover the full match your employer is giving you while also saving for emergencies, your next car, and so forth. Putting too little (and not getting the match) or too much (and not having money accessible) are both problems you will certainly want to avoid.

2. My experience is that even an index fund in a 401k is expensive. Then again, I'm comparing that to the expenses I pay in my Vanguard accounts -- so not sure that's fair. Anyway, look at the expense ratios of all the choices you have in your plan and pick the best option for you. The piece says to complain to your company if the fees are too high, but my experience is that 1) companies aren't going to change a plan for just one person and 2) most people in charge of 401k plans (and yes, this includes executives) don't understand or give much weight to the impact that fees can have on total return over time.

3. 401k loan -- LAST RESORT!!! VERY LAST RESORT!!! I would have to be desperate to take a loan from my 401k. Even if it was a "better deal" to do so, I'd leave that money alone unless I had no other choice.

4. I struggle with keeping my asset allocation up to date. I generally review it once a year and did so a couple weeks ago -- it was "ok" but needed some changes. I also look at asset allocation over all our investments. Any one account could be totally out of whack (for instance, my wife's IRA rollover is all in an international stock index fund), but as a group our investments are where I want them to be.

Anyone else with words of wisdom regarding 401ks?

Comments

[Steve]

For point #1 on "over-contributing", a good solution is to use a Roth IRA to store your emergency fund (not 'irregular expenses', but your true large emergency fund). Emergency funds are often not used, and IRA contributions are capped yearly, so its nice to get money in there whenever you can. Just keep the amount you are considering your emergency fund in a money market within the IRA so if you do need it you wont be market timing if you need to withdraw.

In the end it'll be nice to have a Roth IRA in addition to your 401k anyway given their differences will give you strategic options for withdrawl later on.

[Jane]

The most obvious mistake people make with their 401k: Cashing it out when they change jobs. I KNOW that the 10% penalty should be enough deterrent but for many, many people I've known it is not. These are folks who have never amassed any real savings and that money in that account is burning a figurative hole in their pocket. This is something that was common among friends of ours in our 20's and 30's (a few decades ago), I haven't heard any recently mention it. Apparently once you're in your 50's you generally recognize that you will need that money more in the future than you do right now. It's just a shame to think of how much more they could have if they'd not heeded the impulse of their 30-year-old self. Live and learn.

[Roger @ The Chicago Financial Planner]

Two comments. For some folks who aren't contributing as much as they would like try increasing your deferral percentage by 1% each year. Better if your employer offers this, sign up for the auto increase feature which will increase your deferral percentage automatically.

As for rebalancing many plans offer an auto rebalancing feature this is a great option to ensure that your account stays on track in terms of allocation.

[Lance @ Money Life and More]

My 401(k) fees are actually surprisingly super low! Of course, I do work for a Fortune 500 company though so they have a lot of negotiating power with the 401(k) provider.

[HouseofG]

On point 4, I've started using marketriders.com (found them via bogleheads) both for allocation and, especially, rebalancing monitoring. They are all about index ETFs and funds (even tell you which trades will generate commissions based on your broker), so the low cost investing theory is strongly in play as well.

[Retire By 40]

Trying to time the market? I just sold off most of the equities in my IRA because I think we are due for a correction soon. I want to be in a position to take advantage of a correction.
I don't know if it will work out or not. We'll see.

[Old Limey]

Between 1992 and the end of 2007 I invested entirely in actively managed mutual funds. The only reason to concentrate upon mutual fund fees is if you are going to hold them through good times and bad and are a passive investor.

If you have the market analysis tools and the knowledge and experience required to search for outstanding, well managed, mutual funds that are at the top of the pack in their category, and plan to hold them when they are going up and be out of them when they are going down then fees don't matter.

For an actively managed account, asset allocation is also not important. I used to overweight my best performing fund and ride it up until it started running out of steam and when it was time to start searching for something better.

I haven't had a losing year since I retired in 1992, very few investors can avoid losing years. It takes daily attention and quite a bit of time and is not appropriate for you if you are a very busy person with a full time job that is not able to become an active investor.

At the end of 2007 I was 73, had achieved most of my investment goals, and the market statistics were looking very bad so I decided it was time to move over into the slow lane and become a bond investor and that's where I have been ever since. Now I mainly hold individual bonds but I do have one excellent bond mutual fund that I keep adding to.

[Matt]

I see people raid there 401k when they have emergencies they did not plan for. Lost their job, buy a house,what ever else excuse. I am not sure if you can contribute too much to a 401k because I think alot of people are behind. It was not maxing out until the last 7 years or so that I have been even close to maxing out and finally maxing out.

Another potential place to fail is not having assets outside of the 401k. Nothing in a Roth, house not paid for, no mutual funds or other assets over and above.

I think the ability to draw from different pots of money to minimize the tax implications would be a nice goal.

[Old Limey]

I agree with Matt, raiding a retirement account is one of the worst things that you can possibly do and is extremely shortsighted. My wife and I are in the position now where for the last 7 year we have been taking mandatory distributions from our IRAs. This results in some hefty taxes that have to be paid since the "free ride" doesn't last forever. As we deplete our IRAs our Trust account keeps growing but we minimize the taxes due on it by owning municipal bonds.

You can really have a nice relaxed retirement when your home is paid for, you have no credit card balances, you have a surplus of income from your investments, are getting social security, pensions, are in a really good healthcare plan, and your children are each doing well without needing help from their parents. Of course, the other big issue in old age is your health. It pains me when I see young people doing a lot of things that are detrimental to their health, especially smoking, eating a lot of junk food, and becoming obese.

[Mrs. Pop @ Planting Our Pennies]

If you have complaints or suggestions about your 401K, put it in writing and direct it to HR or your plan administrator via an email. You want to create a paper trail.
As your 401K provider, your employer has a fiduciary responsibility to you, a little known fact. They don't want to get hit with a lawsuit down the line that says you asked for x,y, and z which would have been to your benefit and it was not provided. (Within reason, of course.)
I asked for Vanguard funds in our 401K for low cost ETFs and mutual funds, and the plan administrator looked into it. To get them in, our provider would add surcharge fees which would mean that the savings would be eaten up. To have an independent system that wouldn't do that would require more costs for our employer, which would be eaten up in matching funds benefits. So it's a balancing act. But they researched it, and explained to me why it wasn't in the best interest of everyone in the 401K plan.

[Kevin Womack]

I disagree that taking a loan out of my 401k to pay off debt is a terrible idea. The way I see it, the money in my 401k is a portion of my net-worth that I have little control over. Yes, I can change the investment elections, but these are a few set options that essentially leave me in either the stock or bond market. I want my investment portfolio to be roughly even amounts rental real estate (i.e. real assets) and paper assets (i.e. financial assets I can't really put my hand on like stocks and bonds), but I still want to take advantage of the tax deferred status of the 401k as well as my company's matching. The 401k loans give me a vehicle to do both, I contribute as much as I like to the 401k and then loan the money to my real estate venture. That way I am paying interest to myself rather than a bank, keeping my portfolio balanced the way I like, and still having the advantages of a 401k. The only downfall is if I lose my job and have to pay that money back quickly, but if God forbid that happens, I have real assets with which I could take a mortgage if necessary.
Really, the only difference between a loan of the money in my 401k to myself and allocating money to a bond fund is that I trust the person who owes me a debt much more when that person is me.

[Kevin Watts @Graduatingfromdebt]

Good tips. I recently made the change to match my employer's contribution to the full 2% and it already has made a big difference in my savings. Compound interest really adds up!

[getagrip]

I think overcontributing can be a problem for some. As pointed out in the article it doesn't make sense to not have any real buffer elsewhere in your finances and pour everything into retirement accounts you can't touch without penalty. Hence the usual advice is you're better off ensuring you've got and maintain a large emergency fund before moving to max out your 401K. That said, not everyone made it to the party on time, fully ready to roll, and many enter and leave the party multiple times during their lives. A sole focus on maxing out IRA contributions despite what's going on in your life may not be the best overall financial strategy.

For example, I've made the decision to cut a third on my retirement contributions for now in order to ensure I can get my mortgage paid off prior to ending my 9 to 5 career. It's a trade off and something of a wash, in that if I carry the mortgage into retirement I need a bigger nest egg versus having a smaller nest egg but not needing to take as big a percentage of it. I had been nicely set up to do both, but plans and circumstances change. You rerun your numbers, consider your alternatives, and make your decisions. When things change again, I'll adjust again.

[Martha]

Great tips. Like Kevin, I have also made the changes to match my employer's contribution and I found quite a lot difference in my savings. But I do agree with you that we should not pour everything into retirement accounts.

[jim]

The fees for 401ks vary a lot. From what I've figured it seems that the largest 401k plans tend to do better and its the small employeers who often have plans with higher fees. I think this is simply due to volume and efficiency more than not. It costs a certain amount of money to administer a plan and if you spread that over a lot of people the % cost is low. But spread the overhead over a handful of people and its pricey. Mutual fund expenses and 401k admin fees are a balance and often plans go with pricey mutual funds because the funds give the plan a kickback and that pays the admin fees. I think thats probably what Mrs Pop found when she asked about getting low expense funds.

I'm not entirely opposed to 401k loans. Generally they should be avoided for sure, but I don't quite think they're the 'work of the devil' as some people make them out to be.

[Jose]

I have been contributing just shy of the max to my 401k for a number of years. I can never seem to get to the max. It's a bit of a game though, if you go over your max you might miss out on some employer contributions.