From what expert Liz Pulliam Weston says,
1.)Not signing up:
I've seen a few awful 401(k) plans in my time. One was run by a dentist who forced his employees to help him buy raw land. (That was their only investment option.) Another offered only high-cost, poorly performing variable annuities with surrender charges that lasted for 16 years, meaning workers often had to forfeit a good chunk of their money if they left their jobs and wanted to roll over their accounts.
But such truly heinous plans are few. Most participants get a decent range of investment options (14 choices is typical), reasonable fees and a company match. (About 96% of the large-company plans Hewitt Associates surveyed offer matches.)
There's simply no reason not to participate in a plan that's even halfway decent, yet one out of four eligible workers fail to sign up. That's just dumb.
2.)Missing out on the full company match:
The typical large-company plan matches 50% of your contributions, Hewitt reports, up to 6% of your salary. Your match may not be as generous, but it still makes sense to take maximum advantage of what is essentially free money. Don't think you can afford to contribute enough to get the full match? You're probably wrong. Each dollar you don't put into a company retirement plan is subject to federal, state and local income taxes. So if you're in a 30% combined (federal and state) tax bracket, each buck you toss into a 401(k) will reduce your paycheck by just 70 cents. If you're afraid of going whole hog, just inch your contribution up each quarter by 1% more of your salary. Most people can compensate for the decreased income by bringing lunch from home one or two more times each week.
3.)Taking too little risk:
Most 401(k) investors seem to understand that stock and stock mutual funds are going to give them the best returns in the long run. About 62% of 401(k) assets were invested in equities in 2002, according to the Employee Benefit Research Institute, which surveyed 46,310 plans.But about 16% of the participants EBRI tracked didn't invest anything at all in their 401(k) stock choices. It's understandable that some people would want to lighten up on stocks, either because they were approaching retirement or they learned they weren't quite as risk-tolerant as they thought. But few investors will be able to reach their retirement goals without any exposure at all to equities. Leading financial planners believe the average investor needs to keep at least half of his portfolios invested in stocks, regardless of age, if he wants an adequate income in retirement.
4.)Taking too much risk:
At the opposite end of the scale are the investors who overload on stocks. Nearly 30% put all or nearly all of their money either into their 401(k) equity funds or into their company's stock, with no exposure at all to fixed-income investments.
During the go-go years, it was popular to opine that only old folks needed bonds. The stock market swoon, however, proved that most investors can benefit from the cushioning effect of bonds and cash. Many of the folks who panicked and cashed out at the bottom of the market might have been able to stand pat had they had some bonds adding value to their portfolios. The classic balanced portfolio -- 60% stocks, 30% bonds and 10% cash -- is a good starting point for most investors. You can ratchet up the stock exposure if you're young or aggressive. The risks of putting too much into company stock are so great that I'll give them their own section, otherwise known as:
5.)Drinking the company Kool-Aid
For some people, it's like Enron never happened. The 2001 flameout of this energy trading company decimated the 401(k) balances of its workers. That's because Enron employees put most of their retirement money (62% of the plan's assets as of Dec. 31, 2000) into the company's stock. That debacle should have, once and for all, pounded home the point that you do not want your retirement account riding on the same company that provides your job. Yet, many people still falsely believe that their company's shares are somehow less risky than a diversified mutual fund. Some 23.2% of participants in the 2002 EBRI study who were offered company stock as an option put half or more of their money there. More than one in 10 had all or nearly all (90% or more) of their 401(k) in company stock. What's worse, some of the biggest Kool-Aid sippers were folks in their 60s -- the time when workers can least afford this kind of concentrated risk. One in seven who had access to company stock had all, or nearly all, their money in such shares. If you must invest in company stock, try to limit the overall investment to 10% of your balance. If your company matches your contributions with its own stock -- as Enron did and as others still do -- invest all of your own money elsewhere.
6.)Taking out loans:
What seems like a great idea -- Borrow your own money! Pay yourself interest! -- has plenty of traps for the unwary: The biggest pitfall is the risk you take should you lose your job. Your loan would become due, and, if you couldn't pay it back at once, you would owe income taxes and penalties on the unpaid balance. The interest rate you pay yourself may be lower than what you would pay most other creditors, but paying yourself interest is no substitute for the real return you would be earning if you had invested those payments instead. Borrowing from your retirement funds is often a sign that you're overspending -- particularly if you're using the proceeds to pay off credit card debt. People who use "easy outs" like 401(k) and home-equity loans to pay off their cards often don't change the underlying behavior that put them in the hole. They just run up their balances again, winding up another day older and deeper in debt.
7.)Cashing out:
Next to not signing up, cashing out your 401(k) when you leave a job is the dumbest move you can make with a retirement plan. Yet 42% of the 160,000 401(k) participants Hewitt surveyed in 2002 did just that. The cash-out rates were highest among workers in their 20s. Half of these workers raided their 401(k) accounts rather than rolling them over to IRA accounts or their new employers' plans. They doubtless think they have years to save for retirement, so why not enjoy the cash now? But the younger you are, the bigger the price you pay for a 401(k) cash out. That's because your money, had it been left alone, could have earned tax-deferred returns for decades. That $10,000 you cashed out at 25 could have netted you $200,000 or more in retirement cash, assuming an 8% average annual return and retirement at age 65.
Then there's the tax bite. Combined, the income taxes and penalties you pay typically equal a quarter to nearly half of your early withdrawal. Your 401(k) money isn't a windfall to be blown on vacations or cars or anything else that will be long forgotten by the time you're 65. This money may be all you have to live on. So, treat it with some respect, people.
http://articles.moneycentral.msn.com/RetirementandWills/InvestForRetirement/7MostCommon401kBlunders.aspx
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