A 401(k) account is one of the most powerful tools you can have when it comes to saving for retirement. If you’re not using yours wisely, however, you could be putting your savings in jeopardy. When you’re focused on creating sustainable, long-term wealth through your 401(k), there are certain pitfalls that you need to watch out for along the way.
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1. Choosing the Wrong Asset Allocation
Any successful investor will tell you that one of the keys to growing your nest egg is diversification. By including different types of securities and asset classes in your portfolio, you can spread the risk around so that if the market takes a hit you’re not at risk of losing it all.
Where investors tend to get it wrong with their 401(k)s is not making sure they’ve got the right balance of investments. When you’re younger and you’ve still got 30 or 40 years to go until retirement, you can afford to take a gamble with a stock-heavy portfolio. Workers who are in their 40s or 50s, on the other hand, are in a good position to begin shifting towards safer investments like bonds to insulate themselves from risk.
Day trading within your 401(k) is a relatively new trend and there are a number of plans that now allow investors to actively trade stocks. If you know what you’re doing, trading inside your plan can yield some positive results. But it’s possible to have too much of a good thing.
Overtrading can put your retirement at risk in a couple of different ways. For one thing, your plan administrator could hit you with a penalty or other fees for making excessive trades. Aside from that, frequently switching up securities could end up shrinking your returns if you’re not giving your investments time to grow. That doesn’t mean you need to approach every stock with a buy-and-hold mentality, but you don’t want to let a keeper slip through your fingers either.
Find out now: How much should I save for retirement?
3. Borrowing From Your Plan
Taking out a loan from your 401(k) may seem convenient if you need money to pay off debts or cover unexpected expenses. After all, you’re essentially paying the cash back to yourself instead of paying it back to a bank. So what’s the harm in doing that?
The problem with borrowing from your retirement account is that you’re shrinking your potential returns over time. Not only that but you run the risk of a loan turning into a taxable distribution if you lose your job and you’re on the hook for repaying what you owe in full. If you can’t come up with the money, you’ll have to pay income tax on what you withdrew, along with a 10% early withdrawal penalty if you’re under 59 1/2.
4. Overlooking Fees
Fees can easily erode your 401(k) returns, especially if you’re not paying attention to how much you’re paying. If you’re carrying a portfolio full of mutual funds that have high expense ratios or your plan administrator assesses multiple service fees, that’s money that’s effectively being drained out of your account.
If you’re clueless about the kinds of fees you’re paying, now’s the time to take a look at just how much your investments are costing. Weeding out the ones whose costs aren’t justified by their performance can keep you from throwing money away unnecessarily.
The Bottom Line
When you’re padding your 401(k), there’s no room for error. Making sure that you’re not doing anything to reduce your returns can help you keep your savings strategy on track.
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