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For most people a 401(k) plan is the most important investment vehicle in their retirement plan.  There used to be a time when pension plans sponsored by employers were quite common.  In the old days, employees would stay with the same employer for most of their careers and were rewarded for their loyalty with a nice pension plan that would likely maintain their standard of living for the rest of their lives.  Those privileges are mostly gone.  Nowadays employees need to be in charge of their own retirement plan, including making sure that the plan is sufficiently funded and properly invested to last their entire life span.

This is a tall order for most people, especially if you are not financially savvy.  Most people do not feel that they have the time, energy and expertise to mange their 401(k)s well enough and neglect to make adjustments throughout the lifecycle of the plan to account for changes in life circumstances.  Here are common mistakes that can have a significant impact in your ability to retire based on your 401(k) plan:

Not Making Adjustments

It is important that you review your 401(k) plan or a regular basis to adjust for changes in your life.  For example, as you age your asset allocation should change accordingly and the closer you are from needing to access the money for your day-to-day expenses the more conservative your investment portfolio should be.  This means that as you age a higher percentage of your money should be invested in fixed income investments such as bonds and short-term cash instruments such as money-market accounts.  However, it is important to maintain a percentage of your investment portfolio in the stock market in order to add a growth component to your portfolio.  If you are overly conservative and do not allow for a growth component in your portfolio you run the risk of running out of money due to the effect of inflation.

Another important factor to watch out for is the change in asset allocation that happens naturally to your portfolio as your growth investments tend to outpace your fixed income investments.  Overtime your portfolio may become more aggressive than you intended it to be, and it may be necessary to make adjustments every 1-3 years to make sure you are achieving the desired balance.

Chasing Performance

The other side of the coin is making too many adjustments to your 401(k) in order to chase performance.  If you are constantly switching mutual funds trying to load up on the newest star fund or investment style you may be missing an opportunity to benefit from the long-term effect of buying and holding.  Look for mutual funds that have the characteristics you are looking for in a certain asset class such as investment style, low fees, and long-term performance, and give the fund a chance to work for you over the long run.  If you find yourself switching funds every 1-2 years you may be spending too much time chasing performance.

Another aspect of chasing performance is trying to time the market.  Even the best professional investors cannot accurately time the market and it is a mistake for the average investor to try to change their investment allocation based on market timing.  The best approach is to achieve a risk-adjusted asset allocation balance that you are comfortable with, making small adjustments over time, and letting the investment ride the ups and downs of the market.

Not Taking Full Advantage of Company Match

Many companies match an employee’s investment in their 401(k) account up to a certain amount.  It is very important that you fully fund your 401(k) account to at least the amount that is matched by your company.  For example, let’s assume your salary is $50,000 per year and that your company matches your 401(k) investment dollar for dollar for up to 3% of your salary.  What this means is that for the first $1,500 that you invest in your 401(k) plan the company will give you $1,500 to match your investment.  Therefore, it is very important that every year you invest a minimum of $1,500 in your plan, even if it means making some sacrifices.  Otherwise you are leaving “free” money on the table.  That is a big mistake.

Focusing on Company Stock

Many employers offer their employees the option to invest their 401(k) in company stock.  If your company is doing well and your company stock is growing you may be tempted to load up your 401(k) with your company stock.  The problem with this approach is that your investment portfolio may get out of balance and may be incurring too much risk.

Not only does this run contrary to the key principle of diversification which is the foundation of any good investment strategy, it is also an added risk to your financial well-being because you are already depending on your employer for your income.  If things turn for the worse with your employer’s business, you not only run the risk of seeing your retirement plan take a significant hit, you may also lose your regular income if you get laid off.  That is way too much risk.

Having a portion of your 401(k) portfolio in company stock is OK, but you may want to limit it to no more than 10-15% of your entire investment portfolio.

If you avoid these common mistakes in your 401(k) plan you will increase your chances of achieving success with your retirement plan.

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