Three Big Mistakes When 401(k) Investing

Recently Fidelity and Bankrate.com provided national surveys for 401K savings rates and account balances.  While the headline read “Number of 401(k) Millionaires Hits Record High” I found other data in the surveys even more interesting.  In 2019 the average 401(k) balance increased by 2% to $106,000.  Fidelity also noted that the average employee contribution rate reached a record level of 8.8%, nearly a full percentage point higher than 10 years ago.

Unfortunately, a recent Bankrate.com survey showed that the lowest earners are more than four times as likely as the highest earners to be saving less for retirement.  This has always been the rub with contribution plans.  Plan participants need to contribute.  If your employer is matching your contributions this is “found money” so try to at least contribute to the level of your employer’s match.

OK, the biggest mistake investors make is not contributing enough to their 401(k) plans.   However, there are equally damaging mistakes that can be made once its time to invest. Here are my top three 401(k) investing mistakes that we rectify regularly:

#3 Choosing target dated funds based on your projected retirement age.  Target dated funds automatically move from a healthy equity allocation to the more conservative fixed income allocation as you reach your retirement age.  This systematic approach leaves little thought to how markets are behaving, the path of interest rates, other guaranteed income sources or how long your money will need to last you in retirement.  I find that target funds are too simplistic and tend to place the plan participant into an allocation in their later years that might not be appropriate.  If all you have is target funds as your plan’s choices, don’t select these funds based on the retirement target date.  Instead, make your decision based on the actual stock to bond allocations.

#2 Placing your retirement dollars into retirement.  I can’t tell you how many time we see healthy Americans in there 40’s and 50’s with much or most of their 401(k) assets sitting in the plan’s stable value fund or bonds.  When asked how long this has been going on, the answer is often, “since the last stock market correction”.  Your 401(k) assets will most likely not be considered for distributions until after 59 ½ or beyond so let the market do what it has always done with time; provide better returns than bonds.  There are a number of reasons why the average individual investor has considerably underperformed the stock market over a recent 20 year period.  Trying to time the market and embedded fund fees are certainly culprits.  However, building a portfolio that is too conservative also plays a role in the disparity. The underperformance contrast is dramatic to the tune of a 2.6% annualized return for investors versus the S&P 500 at 7.2%.*

#1 Not participating in a Roth 401(k) provision.  Many 401(k) plans now have a Roth provision.  Unlike Roth IRAs, the Roth 401(k) typically has no income limits on participation. We have found that many clients either have not been notified of the benefit or don’t understand the importance of this provision.  Modeled after the Roth IRA, the Roth 401(k) provides investors an opportunity to fund accounts with after-tax money. No tax deduction is received on contributions to a Roth 401(k) but investors will owe no taxes on qualified distributions.

Ten to 15 percent of pretax income is a good rule of thumb for serious 401(k) retirement investors.  After that, consider maxing out the plan’s Roth provision, or at least set aside as much as you can into this type of account throughout the year. Check with your plan administrator for contribution limits.  The tax benefits the Roth 401(k) will pay off, particularly if you expect your income tax rate to rise over time.

Properly allocated assets and utilizing all of your plan’s benefits are critical to our clients’ overall retirement planning success.  We encourage you to review your plan options annually with your ACM wealth advisor.  If you are a client or considering becoming one, bring your employer contribution plan documents to your next planning meeting.

*Returns are annualized representing the 20-year period ending 12/31/17. Past performance is not indicative of future results.

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