Common 401(k) Mistakes to Avoid

What are common 401k mistakes?

1. Leaving Money at Your Former Employer
This option may or may not be available depending on the former plan. There are a couple of drawbacks to leaving your old 401(k) plan.

Generally, an IRA will have more flexibility with access to thousands of investment choices. Usually, within a 401(k) plan, the investment options are limited. Although these choices are sufficient for a properly diversified portfolio, the plan may not have access to the best or lowest cost investment choices.

One of the biggest advantages of the IRA rollover is the continued tax deferral. You maintain the tax-deferred treatment that was the benefit of the old workplace retirement plan.

Simplification and consolidation of retirement and investment accounts. Attempting to monitor any number of former workplace retirement accounts as you switch jobs throughout your career creates needless complexity. Consistently rolling over your plans to a single rollover IRA creates one account to monitor.

2. Cashing Out
Cashing out is usually the worst mistake you can make. If you do not put the money into a qualified retirement account within 60 days, it is taxed as ordinary income. In addition, you may be subject to a 10% early withdrawal penalty if you are under age 59 ½. Furthermore, you no longer take advantage of the tax-deferred investment over time and the money that could have been generated. This should only be done in the event of a true hardship.
3. Not Having an Age-Appropriate Portfolio
It is common for young people in their 20s and 30s to use an overly conservative investment approach. The reverse may be even more common as many people approaching retirement in their 50s are trying to play catch-up by being overly aggressive.

Younger people should keep in mind that their money is not being accessed for over 20 — or sometimes 30 — years. Rolling returns for stocks over a 20-year period have consistently been higher than fixed income and taking advantage of their long time horizon is important.

Conversely, people in their 50s need to be more cautious in their investment allocation to ensure that they can weather any market storms resulting from any drastic short- to medium-term volatility.

4. Trying to Time the Market
Timing the tops and bottoms of market cycles is an extraordinarily difficult investment strategy. Very few people in the world are capable of timing the market consistently. Panicking and selling once a correction has already started and then trying to get back in when the market turns back positive is a dangerous proposition.
5. Chasing Returns
Multiple studies outline the historical performance of individual investors versus a fully invested portfolio.

Biggest causes of poor performance:

  • Emotions (fear or greed)
  • Investing in the latest top-performing fund
  • Avoiding underperforming areas of the market, assuming recovery will not happen
  • Foregoing their investment plan in an attempt to time moves in and out of the market
6. Failing to Rebalance Your Portfolio
The “set it and forget it” approach to investing is all too common among 401(k) contributors. If the stock or bond market rises or fall dramatically, you could end up with a much bigger or smaller percentage of your portfolio in an asset class than you originally intended. This can be dangerous over time especially as you get closer to retirement.

By rebalancing at least every year, you stick to your investment discipline and have the benefit of essentially buying low and selling higher than you otherwise would. You are also doing it in a disciplined manner and not trying to time big market swings.

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