A 401K Plan refers to an arrangement that allows an employee to choose whether to take compensation in cash or defer a certain percentage of the sum to a 401K plan. The deferred amount is usually not taxable to the employee unless if the sum is withdrawn from the 401K account. Under a 401K plan retirement saving contributions are matched by the employer as well as deducted from the paycheck of the employee before tax.
The 401K plan has long been considered one of the most advantageous and useful cornerstones of any investor’s retirement plans. Although a 401K plan is relatively simply, people often make some grave mistakes that result in costly financial losses.
One of the biggest mistakes made by employees tends to be leaving their money in a former employers 401K plan rather than shifting it into an IRA account. People tend to change jobs often but leaving money in a former employer’s 401K account is unwise. All 401K accounts have administrative charges, which will unnecessarily affect your savings in the long term in a negative manner. IRA accounts, on the other hand, do not carry any such administrative fees and charges. This small action alone could result in saving thousands of valuable dollars. Another reason to switch from the 401K to an IRA account is that while 401K accounts tend to offer high-cost, actively managed fund choices, studies find they are not worth the additional cost to investors and that investors are better served by low-cost, passively managed fund choices.
Another big mistake often made by individuals in regards to their 401K plan is trying to invest their way to retirement, rather than through retirement. There is a significant gap between retirement age and adult mortality age. Many 401K investors make the mistake of becoming conservative too soon and reduce their plan’s stock exposure to 20 percent rather than sustain it at 40 to 60 percent to help provide them a better lifestyle through retirement.
Investors of 401K plans also make a big mistake in timing the markets rather than putting time in the market. Many investors move their 401K investments out of stocks when the market is not performing well. DALBAR, a Boston based research firm, however, looked at past figures and concluded that the average investor who moved their investments out of stocks historically achieved a much lower return on investment. The return on investment paled in comparison to investors who kept their money invested in an S&P 500 index fund. Instead, as per DALBAR, the S&P 500 index fund is a good return on investment as in the last twenty years, the S&P index showed a return rate of 9.22% annually while the a return of just 5.02% per annum was gained by the typical investor. Moving in and out of the markets can cost a few thousand dollars.
One of the most commonly repeated and serious mistakes investors make is not rebalancing their 401K funds. If the stock or bond experiences a magnanimous rise or drop, it could affect your portfolio in a major way that makes you reconsider your retirement plans. Thus, it is advisable to rebalance your 401K plan every year or two years.
Stocks tend to be a better long-term option than bonds due to their profitability. However, in the short-term they can be much more unstable. Thus, it is a good idea to start out your 401K with a majority of your investments in stocks but move to bonds because of their security, as you approach retirement. Rebalancing your investment portfolio is thus a good idea. Another advantage is during rebalancing, you will be buying high and selling low, thus gaining monetarily.