A 401(k) plan is a great way to save for retirement. It lets you set aside pretax money from your paycheck, lowering your taxable earnings. Meanwhile, the money you save in a 401(k) grows tax-free.
Unfortunately, employees often make mistakes when it comes to how much they contribute to their 401(k)s. They might make poor investment choices or even mishandle funds. Here are five things you should avoid doing with your 401(k) so you don’t jeopardize your retirement savings.
1. Own Too Much Company Stock
It might seem like a good idea to own shares of your company’s stock if your employer offers it as an investment option — and nearly 40 percent of plan sponsors do, according to a report by Aon Hewitt, a human capital and management consulting service. But actually there are risks.
If you invest too heavily in your company’s stock, your portfolio won’t be diversified and will be too closely tied to the performance of just one firm, according to the Financial Industry Regulatory Authority. After all, if the company’s performance tanks, your 401(k) balance is sure to go down with it.
Plus, some companies place restrictions on employees’ ability to sell stock, limiting your control over your investments. Ideally, you shouldn’t have more than 10 percent to 20 percent of your total investments in company stock, according to FINRA.
2. Gamble on High-Risk Investments
The most common 401(k) investment choice is the mutual fund, which holds a variety of stocks and bonds. However, some plans let participants buy an assortment of securities through a brokerage account.
Unless you’re an experienced investor, you probably want to leave the stock picking up to the pros so you don’t end up with risky assets. This means you might want to stick with mutual funds. However, you still need to be careful when choosing funds.
You don’t want to take on too much risk by investing only in stock funds. Even the youngest 401(k) plan participants should still allocate 10 percent of their portfolio to bonds, said Jean Young, senior research analyst with the Vanguard Center for Retirement Research.
3. Avoid Stocks Altogether
According to a “How America Saves 2015” report conducted by Vanguard, 5 percent of participants in Vanguard-administered 401(k) plans don’t have any stock holdings in their accounts. This is a mistake even for investors with low risk tolerance or those close to retirement. Because most people can now expect to live 20 to 30 years into retirement, they need the higher rate of return that stocks offer as a hedge against inflation, said Young.
Rather than avoid equities, consider investing in a target-date fund, which automatically adjusts your allocation of stocks and bonds as you approach retirement to lower your risk level. “The asset allocation in our target-date funds is a good proxy for how much equities an individual should hold as they enter retirement,” she said. “It’s about 50 percent equities at age 65.”
4. Set and Forget Your Contribution Level
More and more employers are automatically enrolling employees into workplace retirement plans — which is a good thing because it increases participation and gets people saving. Yet many plan sponsors set the default contribution level for those automatically enrolled at just 3 percent or 4 percent of wages, according to a report by WorldatWork, a nonprofit human resources association. And if the plan doesn’t automatically increase your contribution rate annually or you don’t increase it yourself, you might be at risk of not saving enough for a comfortable retirement.
Most experts recommend saving at least 10 percent to 15 percent of wages annually. At the least, you should be contributing enough to your 401(k) to take full advantage of matching employer contributions. One in four plan participants miss out on receiving a full match by not saving enough, leaving an estimated $1,336 of free money on the table, according to research by Financial Engines, an independent financial advice company.
5. Borrow Heavily From Your Account
Plenty of employees take advantage of 401(k) plan provisions that allow them to borrow from their account. But some borrow heavily, which could put a serious dent in retirement savings. Nearly 30 percent of 401(k) plan participants had multiple outstanding loans in 2013, according to Aon Hewitt.
You can borrow up to half of your 401(k) balance, up to a maximum of $50,000. But you will have to pay yourself back with interest — which can be lower than the rate of return you would’ve gotten if you had left the money in the account. You’re also liable to incur taxes and early withdrawal penalties.
Keeping the money you invest in your 401(k) will help you grow your investments over time, while tackling a healthy amount of risk can ensure your savings last through retirement. Create a healthy balance of risk in your portfolio and periodically check in and adjust your investments as needed.
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