The 6 Most Common 401(k) Investing Mistakes
Over the years, we have observed six errors that can seriously hinder the growth of
a 401(k) plan. Because they are products of human nature, these six challenges are
common among all investors:
1. Not Contributing Enough to Your Plan.
Perhaps the worst mistake an individual could make other than not participating in one's company plan is not contributing the maximum amount - and especially not contributing enough to obtain your company's maximum matching contribution.
The inclination might be to feel the need to maintain a higher level of income today at the expense of contributing more to one's retirement plan. However, many will look back with regret on that decision in their retirement years. Moreover, it makes no sense at all to leave any portion of your company's potential contribution "on the table"
2. Under-investing in the types of growth investments that are needed to
contribute to a successful retirement plan.
Many 401k investors are understandably at a loss for investment direction and are
fearful of losing money. Studies show they are consistently over-invested in bond
funds, guaranteed investment contracts and money market funds and, as a result,
they struggle to achieve significant long-term growth.
3. Being too heavily invested in stock funds at or near market tops, e.g. in 1999-2000.
Another product of human nature causes investors to be lured into stocks most
heavily at market highs. Consequently, when the market falls, they lose more than
they made on the way up. As an example, a Hewitt Associates 401(k) Index survey
found that 401(k) participants' allocation to stocks reached 74 percent in March
of 2000, the highest such level since the inception of the Index in August of 1997.
March of 2000, of course, marked the all-time top of the stock market.
4. Being too heavily invested in one's own company stock.
The Center for Retirement Research at Boston College states in a December
2004 study that "One of the most dramatic failures [in retirement investing] is
that workers often over-invest in their employer's stock." 46 percent of 401(k)
participants hold more than 20 percent of their account balance in employer stock,
and 16 percent hold more than 80 percent. These investors are taking a huge risk.
Even if one's company does not suffer a total, Enron-type collapse, there is still a
very high risk of suffering severe losses. A recent study from Deloitte & Touche LLP
revealed that over a 10-year period through 2003, almost half of the world's 1,000
largest companies suffered one-month stock price declines of more than 20%. Of
the companies suffering those losses, half of them either took more than a year for
their share price to recover or had not yet recovered through the end of the study
5. Not knowing when to sell.
Throughout the ages, investors in every category of investments have been most plagued by the
task of determining when to sell. This is because at market tops, forces like the
Wall St. establishment, the media and your neighbor are all reinforcing the human
natural tendency toward greed. Sooner or later, however, most investments will
suffer significant declines in value. And more often than not, investors will hold
onto those investments until the pressure becomes too great to bear...which
unfortunately may be right near a market bottom.
This problem is reinforced by another Hewitt Associates 401(k) Index survey done
concerning the month of February of 2003. It found that 401(k) money was being
shifted from stock investments to fixed income investments on 89 percent of the
days of that month. That marked the greatest percentage of days in any month in
the Index's history in which 401 (k) investors moved from stock funds to the more
conservative bond fund options. Predictably, within weeks, the stock market would
start a substantial four-year rally.
6. Not knowing what to invest in.
Without the appropriate tools, investors lack guidance in selecting the best options
to invest in, and can end up making serious allocation errors. Such errors include
chasing recent hot areas in the market too late in the game or investing in severely
depressed investments with the hope that, against the odds, they will break out of
their doldrums. As with the points mentioned above, many 401 (k) participants have
neither the time nor the inclination to adequately address this vitally important part
of building a sufficient retirement fund.