4 401(k) Mistakes You Don’t Even Realize You’re Making

You’re maxing out the company match in your 401(k), so that’ll eventually fund your retirement, right? Maybe; maybe not.

Contributing regularly to your 401(k) and collecting your full match are great starting points for funding a comfortable retirement. But these actions alone may not be enough — especially if you’re leaving money on the table with some common 401(k) mistakes.

Make sure that’s not happening with a quick self-check against the four 401(k) missteps below.

Image source: Getty Images.

1. Contributing less than 10%

A contribution rate lower than 10% may not cut it, even if you’re maxing out your match.

Say you make an average salary of $52,520. A 10% contribution equates to $438 monthly. If you’re also earning a 4% matching contribution, that adds $175 — for a total of $613 monthly. It takes a full 35 years of those contributions to amass $1 million, assuming your average growth rate is 7%.

If you have 35 years and your lifestyle doesn’t change dramatically, a $1 million nest egg plus Social Security should fund a comfortable retirement lifestyle.

However, there isn’t much room for error in this plan. A contribution rate lower than 10% would be insufficient if retirement is less than 35 years away. It’s also not enough if you take time off work at some point or pause retirement contributions to, say, start your own business.

2. Choosing 401(k) funds based on history

No doubt you’ve seen the disclaimer on fund documentation: Past results do not predict future returns. We all know this logically, but many investors still gravitate toward funds that have performed well in the past.

Unfortunately, this backward-looking approach can be unreliable. For example, a niche fund might have done well last year because of world events that won’t recur. The same fund could easily fall harder and faster than your other fund options in the months ahead.

You’re better off reviewing the fund’s investment objectives and its expense ratio. The investment objective is what the fund is trying to accomplish. That’s the context you need to evaluate past performance and whether the fund fits into your retirement plan.

The expense ratio is a forward-looking number. It tells you the percentage of your investment that will be diverted to cover fund expenses. Lower is better, because that means more of the investment returns flow through to your bottom line.

3. Over-diversifying

If you’re holding a piece of every fund on your 401(k) menu, you’re over-diversified. Over-diversification can produce minimal returns or high volatility — two outcomes you probably want to avoid.

Most retirement savers only need one or two positions in their 401(k). You can hold a single target date fund by itself. Or, you can hold a large-cap index fund plus a government bond fund. You can get more complicated if you have some investing know-how — but you don’t have to.

4. Letting it ride

Letting your 401(k) run indefinitely without intervention isn’t your best move. Two things can happen as a result:

You’ll miss easy opportunities to raise your contribution rate when your income increases.
If you hold anything but a target date fund, the risk in your portfolio will rise over time. This happens because your stock funds will grow in value faster than your bond funds. As a result, your stocks will comprise a larger and larger percentage of your overall holdings.

Plan on checking in with your 401(k) at least every year at raise time. You can bump up your contribution rate and check your risk level. If your stock exposure is too high, fix it by selling off some of your stock fund shares. Use the proceeds to buy more shares of your bond fund.

An easier path to retirement

Correcting these common 401(k) mistakes can give you a nice push toward the retirement you want. Contributing more now provides wiggle room for the unexpected going forward. Choosing the right funds and doing annual maintenance in your account help you manage risk.

At the end of the day, more money invested at an acceptable risk level is what you need to reach your retirement goals.

10 stocks we like better than Walmart
When our award-winning analyst team has an investing tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now… and Walmart wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

See the 10 stocks

Stock Advisor returns as of 2/14/21

The Motley Fool has a disclosure policy.

Leave a Reply

Your email address will not be published.