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Growing your employer-based retirement account — most commonly a 401(k) — is quite a bit easier than it might appear. Success with retirement investing comes down to getting a few key things right, so it’s best to ensure you’re on the right track from the get-go.
We’ll review four key mistakes that you’d be wise to correct when it comes to investing in your 401(k).
1. Failing to qualify for your company match
Most companies offer a matching contribution to 401(k)s up to a specified percentage of compensation (usually in the 2% to 6% range). For example, if you contribute 5% of your paycheck to your company’s 401(k), the company will match your contribution.
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Using hard numbers, if you earn $100,000 and your company matches contributions up to 5%, you’d be smart to contribute at least 5% to the plan. You’d only have to contribute $5,000 to earn a company match of $5,000, which, when combined, is a nice sum of money for any investor.
The company match functions as a guaranteed 100% return on investment, so it would be a clear mistake to miss out on free cash.
2. Not investing your 401(k) balance
Some people will contribute to their 401(k) plans but for one reason or another will pass on investing their money. This mistake causes you to miss out on compound interest, which is one of the main benefits of investing in the first place.
When it comes to retirement investing — especially for a retirement that will take place many years in the future — holding cash in your 401(k) makes little sense. Be sure to pick from the wide array of mutual funds likely present in your plan and start growing your money as soon as possible.
3. Not reading the vesting rules
When you invest money in a 401(k), you become subject to the company’s vesting schedule. When 401(k) money vests, it’s said to be all yours if you were to separate from the company. Often, employee contributions vest immediately, while employer contributions may take several years or more to fully vest.
401(k) plans come with vesting schedules to incentivize employees to stay for a specific period of time (sometimes two, three, or five years.) Most companies will have you forfeit all or a portion of employer contributions if you leave within the first year of employment, but this is not an ironclad rule.
Read your company’s 401(k) plan document and learn how long you’d need to stay employed to be able to take your entire 401(k) with you, not just the portion you deposited yourself.
4. Investing your entire plan in company stock
Sometimes, companies will allow you to (or even direct you to) invest your 401(k) in company stock. There are a few key issues with this.
First, by being employed at the company, your career (or human capital) is directly tied to company performance. This means that by investing your 401(k) plan only in company stock, you’re also tying your financial capital to the same factor. If your company were to fail or go bankrupt, not only would your job be affected, but your retirement savings could go down along with it.
Second, investing your 401(k) solely in company stock causes you to miss out on the benefits of diversification. By spreading your money around in your 401(k), usually via mutual funds, you’ll spread out your risks at the same time.
Putting all your eggs in one basket in this way is surely a way to introduce trouble to your finances. If you do choose to keep some company stock in your 401(k), make it a modest percentage.
401(k) investing: Get the basics right
Much of what makes a successful 401(k) investor is about completing a few simple tasks repeatedly. To get a better 401(k) outcome, remember to qualify for your company match, invest the money you’ve accumulated, read your company vesting requirements, and avoid concentrating your balance too much in company stock.
If you can make these things happen, there’s a good chance you’ll find retirement investing easier and more fruitful than you’d ever imagine.
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