The 401k is one of the main vehicles for most retirement savers in today’s workforce. While it’s not as attractive as a company pension, it is still a viable means of providing a comfortable retirement for many. However, there can be numerous traps along the way, each of which must be sidestepped to stay on track.
- Starting too late.
We have heard the quote before, “Compounding is the most powerful force in finance.” That quote is said to be from Albert Einstein, which if true, means we should probably listen. If we look to some quick math, we can see just how much of a force it is. Assume two people work for 30 years, both earn a 5% return upon their investments, but Worker A saves for all 30 years while Worker B starts in the beginning of their 10th year. Worker A would have saved $163, 961. Worker B, just $81,702. The sooner one starts, the better.*
- Failing to take advantage of the match.
We have all heard it before, do not miss out on free money. If your company matches your contributions up to 4%, there are few financial situations that justify missing the match. Why? You’re doubling your investment before it spends one full day in the market. If you contribute $100 per paycheck, and receive 26 pays per year, then that is an additional $2,600 above and beyond your own contributions each year.
- Not having the appropriate investments.
It is not uncommon for people to be on opposites of the investment fence. Either they have little idea of what they are invested in and why, or they move things around too much, trying to chase returns in the market. In today’s high tech world, there are many online tools that allow you to gauge your personal investment risk tolerance and along with your time remaining to retirement, an appropriate investment recommendation can be made. This is important to ensure we are not missing out on good returns in strong markets, while also not taking undue risk. On a slightly different note, this also includes rebalancing. If rebalancing is not done on an annual basis, investments have a tendency to get out of balance over time. This causes problem during both poor and strong markets.
- Staying in a 401(k) too long.
While there can be many scenarios to stay in or get out, we’ll look at just two today. The first is when someone retires and stays in the 401(k), missing out cost savings and additional investment options. When an individual leaves their employer, the cost of the 401k may increase due to an administration charge for participants no longer employed with the company. Even if it doesn’t, it pays to shop around and see if an IRA will provide lower overall fees – which should include both account and investment charges. The second relates to an “In-Service Distribution.” While still with your company, you may have the option to roll some of your 401k to an IRA. The benefit is to invest your retirement assets into a product that is not available in your 401(k). This becomes increasingly attractive when one nears retirement.
There are other pitfalls to be aware of that are not mentioned here. Ultimately, your 401(k) needs to be coordinated with a broad financial plan. The closer you are to retirement, the more important that becomes. If you're looking to get the conversation started, feel free to call our office and set an appointment with myself or one of our other advisors today.
The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement. To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.
*Example and figures used as hypothetical illustration only, not indicative of any particular investment experience and may not be representative of the experience of clients. Actual results will vary.