| | Avoiding 401k investing mistakes: October 3, 2006 |
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One of the retirement plans available in the United States is the 401k plan that is available to most employees. The advantage in having a 401k plan is that you can save for your retirement while deferring on income taxes on both your money and its interest. This is an employer sponsored plan that is provided to employees by employers. The main advantage of a 401k plan is that the funds accumulated in the plan can be used for any investment option that includes mutual funds, stocks, money market funds and life insurance.
The amount that is contributed to the 401k plan is decided by both the employer and employee and is a percentage of the employee’s salary. This amount is directly deposited into the 401k plan from the monthly pay check. Some employers pay an amount matching the employee’s in the 401k plan while others may pay more. In case the employee leaves the employer, the employee can keep the 401k plan active with that employer till the end of their lives or transfer the plan to the next employer. Another alternative is to cash out on the money accumulated in the plan; but there may be some interest that has to be paid in such situations.
However, just as beneficial and lucrative as the 401k plan may look, there are some mistakes that are done in 401k plans that can be avoided. One of the greatest mistakes is investing the money that is accumulated in the 401k plan in your own company. Most companies usually offer their own stock as an investment opportunity; however, in case the company lands in a loss, you not only lose your job, but all of your retirement savings too. Its not that you should not invest in your company’s shares; it is better to hold some company stock but make sure that it is a small ratio of no more than 10%.
When making investments from your 401k plan, don’t concentrate on making investments on only large company stocks, but also on small company stocks. This is because size is not a matter of concern in stocks. In fact, it is usually the small company stocks that out-perform the large company stocks in the long run. So instead of just concentrating on investing in large companies, keep a place for small company stocks in your portfolio.
Another mistake most investors of 401k plan is to invest only within the US borders. However, with today’s global economy, an international investment tends to add a level in the diversification of your 401k plan funds. With this, it may prove possible to offer some protection from a weak American dollar. It is always better to consider investing 30 to 50% of your money in international funds that depend on the international options you have, and your comfort level.
It is always better to consider your 401k plan as a whole by using the plan to your advantage. Instead of investing in aggressive investments with your own money, it proves to be tax advantageous for you to buy these investments within your 401k plan. This is more so if your investment is one that has a lot of trading associated with it. Remember, buying and selling of investments through the 401k plan is not a taxable process wherein lots of headache is saved.
Though most employers generally promise that their 401k plans are devoid of unnecessary fees, not all employers promise this. Some plans have some hidden fees associated with them; so confirm on this point. When making investments with the 401k plan funds, it is better to confirm that mutual fund choices are no-load mutual funds. These funds are funds where there are no percentages to be paid to get into and out of the fund.
Another mistake that can be avoided in 401k plans is to confirm that you are not being charged with 12b-1 fees. With this comes another form of hidden fees which is found as the internal expenses of the fund that is calculated with the expense ratio. When you are placed with a choice between two funds with a large growth it is better to go with the fund having lower percentile. This is because the fund with a higher percentile will not be beating the fund with a lower percentile in the long run.
It is always better to diversify your investments that you make with the 401k plan funds. This is basically advice financial experts give for all investments and not only for 401k plans. You should never invest all your funds in a single investment as if the company or stocks fail; you will lose all your money. Instead, if you invest in a few investments, if one falls in failure, you have your money from the other investments.
The most common mistake more than thirty percent of employees do is not to invest in 401k plans. The 401k plan is a great investment to be ready for retirement. So if you are one of the many people who have not started a 401k plan, you are actually missing out on a great opportunity of pretax and tax-deferred means of investment. If you are a bit doubtful of the 401k plan, you can always start with small contributions to the plan. And in the long run, you will learn the benefits of 401k plan. You can then increase the contributions for the 401k plan so that you can get the most of your company matches.
With the mistake of not investing in a 401k plan, you run the risk of not being able to live your present lifestyle on retirement. So to actually enjoy retirement, and have a good retirement, you can develop good plans to reach the ideal retirement. To get the right idea of how much you have to make as an investment for your retirement, you can use the Closing Your Retirement Gap plan. Have a meeting with an investment professional wherein your financial situation will be assessed, and your retirement goals discussed.
Some people may opt to take a loan from the 401k plan; however this option may cost you. This is because though the loan may help you in an emergency, you risk a reduction in the money you will be receiving in retirement. Even cashing in on the 401k plan before retirement is not that worth it. This is because the money loses its tax-deferred status and is subject to income taxes and early withdrawal penalties.
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