Your 401(k) may be one of the most important tools you have for building retirement savings. But simply contributing to your account doesn’t necessarily mean you’re making the most of it.
As you get closer to retirement, decisions about how much you contribute, how your money is invested and how you respond to market changes can become increasingly important.
So, what are some of the most common 401(k) mistakes to avoid?
In short, five mistakes to watch for are not contributing enough to receive your full employer match, borrowing unnecessarily from your account, reducing or stopping contributions, overlooking your investment risk tolerance and trying to time the stock market.
1: Not Contributing Enough to Get the Employer Match
Some employers offer to “match” a percentage of employees’ contributions to their retirement plan. For example, an employer might match 50% of the employee’s plan contribution up to 6% of the employee’s total annual compensation. If you do not contribute at least enough money to your plan accounts to get the full employer match, you are leaving what is essentially “free” money on the table.
2: Taking Plan Loans Without Considering the Long-Term Impact
Many retirement plans offer participants the ability to borrow from their plan accounts once they meet certain conditions. Although it can be reassuring to know that you can access your savings early if you need to, the fact that loans are available does not mean that it’s smart to take loans from your plan.
When you borrow money from your plan account, you’ll have less invested. Until the loan is repaid, you could miss out on growth opportunities. If you leave your current employer while you have an outstanding plan loan, you may have only a limited window of time to repay your loan balance. Otherwise, the unpaid amount will be regarded as a “deemed distribution” that’s taxable to you. You may owe an additional 10% early withdrawal penalty on it as well.
3: Reducing or Stopping Your 401(k) Contributions
Your regular, uninterrupted contributions to the plan have the potential to compound over time. Investing them in an appropriate mix of stock, bond, and cash equivalent investments can help you build up your retirement savings. However, when you reduce the amount you contribute or you stop contributing altogether — even for a year or two — you are disrupting the growth of your savings.
Finding the money to set aside for retirement can be tough, especially when you face so many other financial demands. But it’s important to prioritize saving for your retirement. Otherwise, you might need to push back your retirement date or reduce your expectations as to what you will have available for spending in retirement.
4: Not Understanding Your Investment Risk
Risk is a fact of life for every investor. Some investments, such as stocks, carry a higher risk of principal loss than others. The risk of loss is essentially the price you have to pay for the possibility of higher returns. As a retirement plan investor, you have to figure out how much investment risk you can comfortably handle. Once you have identified your ability to handle the possibility of investing losses, you will be better able to allocate your plan investments in a way that’s appropriate for your risk tolerance.
5: Trying to Time the Stock Market
Some investors believe they can successfully time the stock market. They think they can invest their money in the market at the moment it begins to move upward and get out of the market just as it is about to start falling. Of course, it is impossible to identify the exact moments when the stock market is about to climb or start to decline. All too often, investors end up sitting on the sidelines when the stock market makes one of its sudden bull runs. As a result, the long-term growth of their retirement savings is negatively impacted.
The reality is that time in the market works for retirement plan investors, not timing. By steadily investing in your retirement plan every payday, you are building up your account balance. Moreover, you can also benefit from compounding. The longer your money is invested, the greater potential benefit there is from compounding. Click here for our blog “4 Tips to Help Avoid Timing the Market.”
Should I change my 401(k) investments when the market drops?
A market decline alone isn’t necessarily a reason to make a major change.
Instead, consider whether your investment strategy still aligns with your retirement timeline, risk tolerance and overall financial plan. If it does, short-term market movements may not require an immediate response.
How Often Should You Review Your 401(k)?
A 401(k) shouldn’t be completely “set it and forget it.”
Consider reviewing your account at least periodically and whenever you experience a major financial or life change, such as a new job, salary increase, marriage, approaching retirement or a significant change in your financial goals.
During a review, consider questions such as:
- Am I contributing enough to receive my full employer match?
- Does my contribution rate still support my retirement goals?
- Is my investment allocation appropriate for my retirement timeline?
- Has my comfort with investment risk changed?
- How does my 401(k) fit with my IRAs, Social Security and other retirement resources?
We’d be happy to help you along your retirement planning journey. For assistance in reviewing your retirement plan portfolio and your investing strategy, schedule a meeting with our team.
