By Gary Brooks, CFP®
As we draw closer to the end of the year, many employees will soon get emails from Human Resources reminding them about open enrollment for 2018 benefits. For many, one key benefit is access to an employer-sponsored retirement plan, such as a 401k, 403b or 457. While most plans are far from perfect, they can help you save more so you can successfully fund your retirement. If you participate in one of these employer-provided plans, what mistakes should you avoid to make the most out of this saving and investing opportunity?
Of course, the most obvious mistake is failing to participate. The second is not contributing enough to earn the potential free money from a matching contribution from your employer. Those are givens; they appear in every article you’ve probably ever read about 401k plans. So, let’s assume that you are participating and earning a match if your employer offers one. Now, let’s focus on other potential pitfalls that could reduce your chances of saving enough for retirement.
Not having a goal. It used to be that more companies offered traditional defined benefit pension plans where the responsibility for generating lifetime retirement income was shouldered by employers. In these cases, actuaries determine a specific account value goal for each employee, incorporating their income, age and expected retirement date. This allowed professional investment firms to manage the money in the plan with the retirement income obligations in mind.
Now, most employees participate in defined contribution retirement plans. These put the saving and investing responsibilities on employees. Most people don’t use a similar approach as the actuaries described above. You can, however, determine the level of savings needed to produce an income stream to replace your salary. When you do, you’ll be better prepared to make investment decisions aligned with that goal.
Not thinking holistically. Many people have investments outside of their employer retirement plan, but fail to think about how all their investments fit together. The most common issue is a lack of coordination between the retirement plan investments of spouses.
You should think about all your retirement-focused investments as pieces of the same pie and understand what they represent as a combined portfolio. If you have multiple accounts (employer plans and IRAs), try to identify the best options available within each to create a collectively prudent investment portfolio. For example, if your spouse’s 401k has better bond funds than your plan, use it instead and weigh your contributions to the best investment funds in your plan. If there are gaps in your 401k choices (usually limited selection for bonds and international stocks), use a different account, such as an IRA or taxable account, to fill them.
Not factoring in all the risks. There are many ways that people take on more risk than they are aware of.
- Employer stock. Defined benefit pension plans are legally limited to investing no more than 10 percent of assets in employer stock. You should treat your holdings the same way. You already have a lot of financial risk tied to your employer; they pay your salary. Don’t also increase your market risk by holding too much of your employer’s stock. Even if you can buy it at a discount, it’s risky to overload your portfolio with a big bet in a single company.
- Investing too conservatively. Stable value or short-term investment options look relatively attractive when the investment markets are declining. But historically, these investments have not outpaced inflation.
- Not rebalancing. Stocks and bonds advance and decline at different rates. Over time, if you have a combination of the two that represents your ideal mix, performance will cause the weight of each to stray from your target allocation. You should periodically rebalance back to your target to try to keep your investment risk level the same over time.
- Chasing performance. Following the recent best performing stocks or mutual funds will often cause you to buy at inflated prices. This is the opposite of buy low, sell high.
After you leave your employer, you often have the choice of leaving your retirement plan assets in your former employer’s plan, or rolling these assets over into a new employers’ retirement plan or to a rollover IRA. If you choose to rollover these assets to an IRA, you will have access to more investment choices and better ability to control costs. If you’ve changed jobs more than once, you also have the opportunity to consolidate retirement accounts into a single IRA that will be easier to manage.
Saving for retirement can be a daunting task. If you don’t feel like you are well-informed by your employer or retirement plan provider, request more clear information or find a financial advisor that you trust who can help you give your nest egg the attention it deserves.
A similar version of this article by Gary Brooks was first published in The News Tribune in March 2009.
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