Top 5 Mistakes in 401(K) Investing

Laura Rowley, one of my favorite Yahoo! Finance columnists, posted a list of the top five mistakes of 401(k) on Friday and I wanted to take a closer look at some of them.

Mistake #1: Failure To Enroll In An Employer’s Plan
Whenever I hear one of my friends tell me that they aren’t participating in their employer’s 401(k), especially when there’s a company match, it absolutely boggles my mind. First, if your employer offers a company match, why are over 30% of employees potentially leaving money on the table? The statistics Laura cites are very illustrative of who doesn’t take advantage – young earners and lower income earners.

Mistake #2: Contributing Only Enough To Get The Employer Match
The average contribution to a 401(k) was 7.31%, the median was 6%, which in most companies is just enough to get the match. While I don’t fault some for approaching this strategy, I did so when I was looking to sock away money for a down payment on a house; it’s not a good long term strategy because you may not save enough for your retirement.

Mistake #3: Keeping Too Much Of Your 401(k) In Company Stock
This is the “eggs in one basket” syndrome and in general it is a bad idea, but sometimes it can pay off. The problem is you look like a genius if you get the payoff, but you’re stuck in the poorhouse for the rest of your life if you don’t. Take this anecdote from Enron: The Smartest Guys in the Room:

A 30-year veteran of an electric utility acquired by Enron had his entire portfolio in Enron stock. At the height, his 401(k) was valued at nearly $400,000. He ultimately sold his shares for $1,200.

Mistake #4: Taking a Loan From Your 401(k)

20% of workers have a loan out on their 401(k), which superficially may seem like a good idea since you’ll be paying yourself interest. However, this lets Uncle Sam tax your money twice. Say you borrow $1,000 from your 401(k), as you pay it back you’ll be paying with after-tax dollars. Then, when you take disbursements from your 401(k), the $1,000 from your account is taxed once again. Ouch!

Mistake #5: Failure To Properly Allocate Savings
This refers to how you’re allocating the money you’ve put into your 401(k). Vanguard found that 13% of their participants had it all in cash! Cash! 19% had them all in stocks! Stocks! This mistake also refers to how people don’t rebalance their portfolios every few years to ensure their allocations remain the same. Personally, I put it in a life-cycle or target retirement fund of some kind and let a professional do the work for me.

Source: Yahoo Finance