Common 401k Investment Mistakes
The days of the company pension providing workers with an income stream through the retirement years is quickly fading away. Today, most workers are responsible for their own retirement savings and this is most commonly done through the company-sponsored retirement plan. These plans can go by different names and numbers, like 401(k) or 403(b), but they all have a lot of similarities. One of those being that most employees are responsible for making the contributions and picking their own investments. Today, we want to look at some common investment mistakes that participants in these workplace plans make in an effort to be better managers of the money that’s supposed to pay for our retirement years.
The following recording is from “Mornings with Kelli and Steve” on Moody Radio Indiana (97.9 FM). For more information on Moody Radio, go to moodyradio.org/indiana.
When it comes to our retirement plans, what do you think about asking or taking investment advice from our co-workers?
The stories we hear from other investors are often very similar to the stories we read on social media. They typically aren’t a very accurate reflection of reality. When you listen to someone talk about their investments, you’ll probably only hear about all the good decisions they’ve made and come off sounding like experts or they’ll tell you about all their mistakes and focus on the negatives and tell you how you shouldn’t invest. In either case, you’re probably not getting the full story and it certainly won’t be the advice that best relates to your decisions. You need to make sure any advice you get is relevant to your situation and not try to apply what someone else is doing to your life.
Is it a good idea to compare the performance of my investment options and make my choices based on that information?
That’s normally a pretty terrible investment approach. It’s what we call “chasing returns.” A common flaw in investing is to believe that what’s happened in the past will continue to happen in the future. Unfortunately, that’s just not true. When we focus on the returns, we’re not taking into consideration why those funds earned their specific returns. In many cases, it’s a short-term move in a specific type of investment and you’re now buying after that investment has already gone up. It’s the exact opposite of buy low, sell high.
I always like to say that when you look at past performance of the investments you didn’t own, you’re looking at returns you’ll also never earn. It’s better to put the time into making a good plan and sticking with it until there’s a good reason to make a change.
Do you find that people often take the wrong amount of investment risk and what’s the potential danger of that mistake?
Risk and return go hand in hand. There are two ways that people typically mess up. We can avoid risk and not earn the returns we may need to grow our retirement savings or we can take too much risk and potentially lose some of the money we need for retirement.
In order to take the appropriate amount of risk, we want to look at our timeframe to retirement and then match our investment risk to that length of time so that our risk of loss is minimized while still trying to earn as much return as we can.
Are there easy ways for people to match up timeframe and risk like you’re talking about?
Target Date funds have grown in popularity over the last few years and are now offered in a lot of plans. Most people have a general idea of when they would like to retire and these investments are designed to match up with your retirement date. The funds will have a date in their name and all you need to do is pick the fund with a retirement date close to when you plan to retire. The investment manager will figure out what mixture of stocks and bonds has the right amount of risk for that time frame. As you get closer to retirement, these investments automatically decrease the risk until it eventually flattens out in the retirement years.
We’ve heard of people getting wealthy because they received stock in the company they were working for and it performed really well. Are there also potential dangers in putting too much of our retirement money in our company’s stock?
It’s easy to get excited about the place where we work. We know the people making the decisions and we know the ins and outs of the company well. The problem is that when you heavily invest in your company stock, you’re not only taking on more risk by not diversifying, you’re taking an especially dangerous form of risk. It’s one thing to take risk by investing in a specific company. It’s an entirely different level of risk when you bet your retirement savings on the same company that is responsible for giving you your paycheck.
To give you an example, my wife worked for a company where people heavily invested in the company stock. She eventually left that job, but not long after, that stock lost 95% of its value in a very short period of time and the company was sold. A lot of people not only lost their jobs, but their retirement accounts also took a big hit.
There are other good investments out there that will provide you with a good return. Be careful of putting too many of your eggs in the employer’s basket.
Brad Graber, CFP® has been working with clients on personal financial planning and investment issues since 1996. He invests his time mentoring and educating individuals on ways to be better stewards of the resources God has entrusted to them.