You've gotten the message and finally invested in your workplace's 401(k) plan. The decision puts you in better shape than the staggering one-third of Americans who have no retirement savings — but it's not enough to simply enroll. You want to make smart choices.
"Don't think you have to become a professional money manager to get this right," certified financial planner Harriet J. Brackey told CNBC.com. "It's not rocket science, you can make a good informed decision if you just slow down." Here are nine mistakes to avoid.
1. Not setting aside enough money.
As a general guideline, financial experts advise putting 10 percent to 15 percent of your paycheck toward retirement, starting in your 20s. (You can get a tailored sense of what's right for you using an online calculator like this one.) The caveat here is that something is better than nothing, so if you can't afford to have that much taken out, settle on a number that you feel comfortable with. Keep in mind, too, what it takes to earn a company match (more on that later).
2. Never increasing your contribution.
Once you pick a contribution amount, it's automatically taken as a pre-tax deduction from each paycheck — which makes it easy to become complacent. But experts suggest increasing your contribution rate by at least 1 percent each time you get a raise (keeping in mind any annual contribution limits). "It's likely you won't feel the difference in your paycheck, [and] the impact on your nest egg will be noticeable once you reach retirement," Smart401k president Scott Holsopple told U.S. News & World Report. This is especially important if you started out saving less than 10 percent.
3. Failing to take advantage of a company match.
Many companies offer matching 401(k) contributions, up to a fixed amount, if employees designate at least a certain percentage of their pay toward their plans. This one should be a no-brainer, and yet last year, 23 percent of employees didn't get their full match. "When you ignore the company match you are essentially turning down a tax-free raise," certified financial planner David Rae told Investopedia. "It's free money. No matter what, you need to contribute enough to get the full company match — this is the bare minimum."
4. Not understanding your plan's investment options.
When it comes to deciding where to direct your money, you will probably have a menu of options including stocks, bonds, and mutual funds. Some may be target-date funds, which key off the year when a person plans to retire (the name of the fund likely contains the year); each is a self-contained, diverse portfolio unto itself, and managers update and reallocate the assets, shifting to more conservative investments, as the target year approaches.
While it's easy to check the box for your plan's default investment choice, you'd do well to review all the options before deciding. For example, you want funds with better-than-average returns, meaning they performed in the top half — and ideally the top 25 percent — of their peer group over a three-, five-, and 10-year span. You also want a combination of investments that suits your risk tolerance (the closer you are to retirement, the safer you'll want to be). In addition, be sure to research fees, which can work against your over time.
Bear in mind that your workplace's 401(k) plan may not have investment options that you like; don't feel stuck — you can look elsewhere to open an account for retirement savings. If you're in a match situation, invest enough to get the match and then go elsewhere.
5. Not rebalancing your portfolio.
Unless you've invested in a fund that's automatically managed, like a target-date fund, it's important to rebalance your portfolio once a year. You want to keep tabs on how your money is doing and whether certain investments are yielding greater returns than others — and then reallocate accordingly. For example, if you made significant earnings from a growth-stock, you might want to move them to a safer investment rather than risk losing those gains.
6. Making decisions based on the news.
Your balance is going to go up and down, and when the financial news is especially bad, it's tempting to react to resulting dips by making a change. Resist the urge! Investing in a 401(k) is a long-term proposition, and reacting to short-term fluctuations is liable to short-circuit your progress.
7. Not taking advice when it's available.
Don't be shy. Many employers bring in an investment adviser to speak with employees, free of charge, a few times over the course of the year. You're not required to follow their advice, and it's a great time to ask questions.
8. Borrowing from your 401(k).
Many companies allow you to do this at a decent interest rate, but there's risk involved. If you don't pay back the loan on schedule, it converts to a withdrawal and the money becomes taxable — plus you will owe a 10 percent penalty if you are younger than the 59 1/2 withdrawal age. Also, if you lose your job or change jobs, the amount borrowed will have to be paid back immediately or it will be considered a cash withdrawal and, again, incur fees.
9. Cashing out your 401(k) after leaving a job.
One in five workers empties an old retirement account within five years of leaving a job. But if you cash out, you'll miss all the compound interest that would have accumulated until retirement — plus you'll pay early-withdrawal penalties. Leaving the account alone would be a better option. Better still — roll the funds over to your new workplace 401(k) plan or to an IRA. Consolidating means you'll have fewer statements to keep track of, less overlap in investments, and you won't have to rebalance accounts multiple times.