Avoiding 401(k) Pitfalls
- By:
- Catherine Brock | February 05, 2008
Make sure that your retirement years are truly golden by steering clear of these 401(k) investment no-nos.
Happy-go-lucky cartoon character George of the Jungle spent his days swinging through vines and talking with apes. Unfortunately for George, his vine-swinging was routinely interrupted by his own forceful collision into a tree, even as his jungle friends tried to warn him. When it comes to your retirement, you can't afford to be like George; keep the momentum going in your savings by avoiding these common 401(k) pitfalls.
Diversification is the name of the game in investing. The purpose of this strategy is to spread out your exposure over different companies, industries, and security types. Picking just one mutual fund really isn't sufficient. You're better off choosing a few mutual funds, making sure that they vary from one another in investment focus and asset type. If you have another investment account besides your 401(k), don't duplicate your choices.
You might be inclined to choose large-cap mutual funds because they hold the companies you know: Microsoft, Wells Fargo, AT&T, Dell, etc. Companies like these are large and typically stable, but they're also relatively mature. Such companies exhibit slower rates of growth than smaller firms would. Therefore, if you leave too much of your portfolio invested in large-caps, you could be missing out on higher growth rates available in small-cap funds. Small-caps often have a higher risk, but you can minimize some of this by diversifying.
There are two ways mutual funds hit you with fees. The first is through transaction fees on either the front- or back-end (called "loads"). Front-end loads are charged when you purchase the security, while back-end fees are charged when you sell it. You can avoid both with no-load mutual funds.
Mutual funds also have internal costs that can dilute your rate of return. These include the fund manager's salary, and various administrative costs associated with maintaining the fund. Internal costs are expressed to investors as fund expense ratios, which are found in the prospectus. All else being equal, a lower expense ratio is better because it means a higher percentage of your money is being put towards the actual investments in the fund. Index funds typically have low expense ratios, while actively managed funds have higher ones.
Your employer may give you the opportunity to buy company stock at a discount. Don't take this as an invitation to put all your holdings into your employer. Over-investing in the company that you work for puts too much of your future in the hands of just one business. It also runs contrary to diversification.
Heed this friendly advice and give yourself a good chance of building a sizeable retirement nest egg. If not, you can keep swinging merrily along like George-but don't say that we didn't warn you.
Happy-go-lucky cartoon character George of the Jungle spent his days swinging through vines and talking with apes. Unfortunately for George, his vine-swinging was routinely interrupted by his own forceful collision into a tree, even as his jungle friends tried to warn him. When it comes to your retirement, you can't afford to be like George; keep the momentum going in your savings by avoiding these common 401(k) pitfalls.
Investing too narrowly
Diversification is the name of the game in investing. The purpose of this strategy is to spread out your exposure over different companies, industries, and security types. Picking just one mutual fund really isn't sufficient. You're better off choosing a few mutual funds, making sure that they vary from one another in investment focus and asset type. If you have another investment account besides your 401(k), don't duplicate your choices.
Depending too much on the familiar
You might be inclined to choose large-cap mutual funds because they hold the companies you know: Microsoft, Wells Fargo, AT&T, Dell, etc. Companies like these are large and typically stable, but they're also relatively mature. Such companies exhibit slower rates of growth than smaller firms would. Therefore, if you leave too much of your portfolio invested in large-caps, you could be missing out on higher growth rates available in small-cap funds. Small-caps often have a higher risk, but you can minimize some of this by diversifying.
Diluting your balance with too many fees
There are two ways mutual funds hit you with fees. The first is through transaction fees on either the front- or back-end (called "loads"). Front-end loads are charged when you purchase the security, while back-end fees are charged when you sell it. You can avoid both with no-load mutual funds.
Mutual funds also have internal costs that can dilute your rate of return. These include the fund manager's salary, and various administrative costs associated with maintaining the fund. Internal costs are expressed to investors as fund expense ratios, which are found in the prospectus. All else being equal, a lower expense ratio is better because it means a higher percentage of your money is being put towards the actual investments in the fund. Index funds typically have low expense ratios, while actively managed funds have higher ones.
Buying too much of your employer's stock
Your employer may give you the opportunity to buy company stock at a discount. Don't take this as an invitation to put all your holdings into your employer. Over-investing in the company that you work for puts too much of your future in the hands of just one business. It also runs contrary to diversification.
Heed this friendly advice and give yourself a good chance of building a sizeable retirement nest egg. If not, you can keep swinging merrily along like George-but don't say that we didn't warn you.
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