5 Mistakes to avoid while investing in 401ks

Saving for the last leg of one’s life is ideally what should be done while heading there. But not everyone has access to retirement plans. Even though you have access to 401k plans there are chances that you take one misguided step and miss the opportunity to maximize the investment. Here are some tips that will help you avoid the common mistakes and ensure you do not fall short of retirement money when it’s time to enjoy it.

­1. Avoid high fees funds

Funds that are included in your 401k accounts come bearing costs. Some of these costs are borne by your employer but others are passed over to you, these get deducted from the account. In the long haul, these costs can eat up your savings leaving less for you in the senior years.

Traits that make a 401k plan expensive are as follows:

a. High Expense Ratio – Expense ratio is the amount charged by a firm to manage your investments.

For example – If you have $25,000 invested in a fund with a 1% expense ratio you will be paying $250 every year till the time your money is invested in that fund. This will be lower than the returns on an identical investment with no expense ratios.

Investment funds charge anywhere from 0 basis points (0.00%) to 150 basis points (1.5%). As an Investor, you should review the expense ratio and try to pick low fee funds with good returns over a longer period such as 3 or 5 years or more. Picking the right options can save you up to $131,255 in hidden fees.

b. High Fees – The fees that we pay to the funds can be broken down into the following categories:

Administrative FeeThese are the charges involved in managing daily operations for managing the 401k account. 
Investment FeeIt is charged for managing the investments or any related services. It is also called the expense ratio.
Individual FeeIt is paid for opting for services that are optional like taking a loan or any other services of that sort.

Zero Fee Funds have also gained traction in recent years if higher returns than the other options. You should be open to different options before deciding one or few according to your liking.

2. Diversify –

401k plans offer a wide variety of investment options. In a typical plan, there are 15-20 investment options. These options usually consist of Mutual Funds or ETFs. Except for target-date funds, each of these mutual funds focuses on a particular market and asset class. For example, Vanguard 500 Index Fund Admiral Shares (VFIAX) has exposure to companies included in the S&P500 index. Similarly, Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) provides exposure to US investment-grade bonds. An individual should invest in various options to diversify risk based on his or her investment strategy. There are tools/apps available such as Plootus to assist you in creating a diversified portfolio. 

Any stock or bond-based Some companies also allow employees to invest their company stock. This may be a great idea, especially if the company you work for has a solid track record and has good prospects. However, you must remember that your company stock is not a diversified investment like a typical mutual fund

Putting all the eggs in one basket is a dangerous affair for any investor. But for an employee looking to invest his 401k savings in his own company is nothing more than double trouble. If the company goes through a rough patch, the individual is not only at risk of losing their job but also all of their finances. Diversifying your investments will minimize risks and maximize savings as it blends different asset classes like mutual funds, single stocks, bonds exchange-traded funds, index funds, and real estate in your portfolio. A variety of investments tend to yield better returns over a longer period.

3. Contribute to take full benefit of employer match

A company offering 401k plans to its employees may also bundle it with a “match”. An employer may match employees’ contribution by putting an amount in their 401k account. This amount is usually a percentage of employees’ 401k contribution, it can even be up to 100%.

In a typical scenario, the employers match 50% when the employees contribute up to 6% of their pay.

Example: If Max decides that he cannot contribute 6% but instead puts 3% of his salary to his fund and his annual salary is $60,000. At the end of the year, he would have $2,700 (including $1,800 of his and $9,00 of his employer’s contributions) where he could have had $5,400 (including $3,600 of his and $1,800 of his employers’ contributions). He missed the opportunity to double his retirement savings.

Such choices can eat away a huge portion of your retirement savings on a longer-term basis.

4. Do not withdraw before 591/2 years

Withdrawing money from 401k accounts before its maturity can have serious consequences to one’s financial health and lesser savings for your future.

Rules for withdrawal differ for people falling into age categories of 55 & younger, 55-59 ½ and 59 ½ – 72

If the person wanting to withdraw falls in the 55 & younger category then he can claim for hardship withdrawals, apply for loans. These are the most common ways to get one’s money in this category, but the person will have to incur penalties and additional taxes for the withdrawal.

For an individual between 55-59 ½, many plans allow him to make penalty-free withdrawal albeit he retired from his job, not before the age of 55. This rule is void if he retires even a year before turning 55 and he or she can end up paying 10% as a penalty fee.

59 ½ to 72, for this category you can access the funds without any penalties if you have retired but if you are still working some plans allow “in-service” withdrawals


5.  Do not over-invest in the company’s stock

Putting all the eggs in one basket is a risky affair no matter what your line of work is. An employee looking to invest his 401k savings in his own company is nothing more than double trouble. If the company goes through a rough patch, the individual is not only at risk of losing their job but also all their retirement assets.

This does not mean that you should not invest in your company’s stocks ever. YOU CAN! But plan not to overinvest. As a thumb rule, Plootus recommends not to invest more than 10% of your contribution in your employer’s stock and the rest should be diversified across different investment options per your investment strategy.

Saving for retirement is not an easy job but with the right guidance and by following the correct steps to avoid these 5 mistakes, one can take advantage of the 401k plan to its fullest.

Be safe and healthy,

Team Plootus.

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