Don’t Make These Common Investing Mistakes With Your 401(k)

March 17, 2016

In our CEO’s new book, What Your Financial Advisor Isn’t Telling You: 10 Essential Truths You Need to Know About Your Money, Liz Davidson writes about how the best place to invest your money is often where you made that money: your workplace. While most people generally understand the value of contributing to their retirement plan, there’s a lot of confusion about how they should choose investments. Here are the biggest mistakes I see people making:

1) Not wanting to take any risks at all. Ironically, putting all of your money into the “safest” investment option like a money market or stable value fund exposes you to the biggest risk of all: not having enough money in retirement. A 25 yr-old saving $5k a year would have $620k at age 67 with a 6% average annualized return but only $184k with a 1% return. If you’re going to invest that conservatively, use a retirement calculator to make sure you can still retire with a return of 1% or less on your money.

2) Chasing performance. When choosing between different investments, it seems to make sense to pick the one with the best returns. After all, past performance is a good indicator of future performance in most areas of life…but not investing. In fact, all investments go through cycles or outperformance and underperformance so if you choose the top performing investment, you’re likely to be picking whatever happens to be closest to the top of its cycle. When it eventually underperforms, you’ll be tempted to sell. That’s called buying high and selling low.

If you really want to chase performance, chase long term performance by putting more of your portfolio in stocks. While stocks have their share of losing years, they have consistently outperformed bonds and cash over long time periods. Just be sure to be patient during those imevitable periods when they underperform.

3) Trying to predict the winners. Fund managers typically try to beat the market by making bets on which stocks, sectors, or asset classes will outperform but very few of them succeed over any given time period and none consistently. Do you really think you’ll be more successful in your spare time? If you can’t help yourself, at least limit your speculation to a small part of your portfolio.

4) Not being diversified enough. While the stock market as a whole isn’t going to go to zero (short of the end of the world, in which case your portfolio will be the last of your worries), an individual stock can. Having too much in employer stock is even more risky because if something happens to your company, you could find yourself out of a job and your savings decimated at the same time. If you want to invest in a particular stock, limit it to no more than 10-15% of your overall portfolio.

5) Being improperly diversified. Randomly spreading your money out between the investment options in your plan might be better than not being diversified at all but the mix might not match your personal tolerance for risk. If it’s too conservative, your returns might be lower than expected. If it’s too aggressive, you might be tempted to bail out during the next market downturn or you may have to sell investments at a loss if you retire during a down year in the market. If you’re not sure how to diversify your portfolio, you can use this guide based on your risk tolerance.

Fortunately, many 401(k) plans have made it easy to avoid these mistakes by including pre-mixed funds like target date retirement funds.  These are fully-diversified “one stop shops” that automatically become more conservative as you get closer to the target retirement date so all you have to do is pick one target date fund that’s closest to the year you think you’ll retire, put all of your money into it, and forget it. You don’t need to research investments, follow the market, or make predictions. In fact, the less you look at your account the better off you’ll be. As long as you continue to contribute, your effort is better focused on earning money so you’ll have something to invest in the first place.