The Experts: The Biggest 401(k) Mistakes to Avoid

Journal Reports for the Wall St Journal writes: What is the biggest mistake people make with their 401(k)s? The Wall Street Journal put this question to The Experts, an exclusive group of industry and academic thought leaders who engage in in-depth online discussions of topics from the print Report. This question relates to a recent article about how IRA payments may avoid state income tax and formed the basis of a discussion in The Experts stream on July 11.

Carl Wiens

The Experts will discuss topics raised in this month's Investing in Funds & ETFs Report and other Wall Street Journal Reports. Find the finance Experts stream, watch recent interactive videos and explore a host of other exciting online content at WSJ.com/WealthReport.

Also be sure to watch investment adviser Tom Brakke(@researchpuzzler), blogger Mike Piper (@michaelrpiper) and University of California, Berkeley, Professor Terrance Odean in an interactive video chat that aired on July 8 in which they  discussed strategies for coping with market volatility.

Terrance Odean: Don't Hold On to Your Own Company's Stock

What is the biggest mistake people make with their 401(k)s? Buying and holding their employer's stock in a 401(k). If your company gives you stock, by all means take it. But sell it soon after you are allowed to do so. If your company does great, you may regret not having loaded up on its stock, but not as much as you will regret losing your life savings along with your job if your company folds (as happened to some Enron employees who had 100% of their 401(k) plan invested in Enron stock).

Terrance Odean is the Rudd Family Foundation professor and chairman of the finance group at Haas School of Business, University of California, Berkeley.

Manisha Thakor: Act According to Your Age

The biggest mistake I see with 401(k)s is being too conservative in their investment approach when they are young and too aggressive with their investment approach when older.

It's understandable. When you first start investing in a 401k the $50, $100 or more that you are contributing a pay period feels like a huge bite out of your paycheck. Thus a natural tendency is to want to protect that hard-earned money. Yet because this money is intended not to be accessed until you are at least 59½ years old, your early years are exactly the ones where you should be taking the most risk. When a person is in their 20s, 30s and early 40s I like to see them as close to 100% in equities as they can stomach in their 401(k).

Conversely, I notice individuals in their late 40s and into their 50s often panicking that they did not save enough early on, so they try to make up for lost time by increasing the aggressiveness of their portfolio holdings. A better option would be to save more and plan to work a wee bit longer. The compound effect of those two activities, statistically speaking, will give you greater odds of getting where you want to go versus swinging for the fences with a hyperaggressive allocation when you don't have the years to make up for a significant loss of principal.

Manisha Thakor (@ManishaThakor) is founder and chief executive of Santa Fe, N.M.-based MoneyZen Wealth Management LLC.

Sheryl Garrett: Stop the Excuses and Save More

There are many common mistakes we see; however, I'd have to say that the biggest one is lack of sufficient savings. If you haven't been saving at least 10% of your gross income since your 20s, you're probably not saving enough for retirement.

Some people fear that the market is too volatile or risky for them to invest. Others argue that they just can't afford to save or save much right now. Well folks, it rarely gets any better. If you can't afford to save for your future now, what's going to change? When you're in the accumulation phase, volatility can work to your advantage. Time becomes your enemy as the power of compound interest can't work for you.

Start or increase your savings rate by 2%. You'll hardly notice it. After three to six months, bump it up another 2%. Over time, you'll get your savings rate up to the place it needs to be. Give yourself some time, but be persistent.

Sheryl Garrett (@SherylGarrett) is founder of the Garrett Planning Network Inc.

Tom Brakke: Different Features, Different Pitfalls to Avoid

It really depends on the features of a particular 401(k) plan. Some people put too much into their company stock, for example. Borrowing against the plan can inhibit the building of a long-term nest egg. Often, people invest in too many different investments, usually based upon past performance figures. All of those approaches are problematic.

The right strategy will depend on the available options in the plan, which are determined by the plan sponsor rather than the investor. Too often, the options have fees that are too high. A simple, cheap index-fund approach is probably the best for most people, but many plan sponsors don't provide that alternative. That's unfortunate.

Tom Brakke (@researchpuzzler) is a consultant, writer and investment adviser who specializes in the analysis of investment decision making and the communication of investment ideas.

George Papadopoulos: Maximize Contributions as Early as Possible

With so many potential mistakes to choose from, it is no easy task to pick the biggest: undercontributing, not signing up for the plan because "we cannot afford it" (you cannot afford to not afford it!), picking high-cost funds (sometimes the fund lineup does not have any low-cost funds), not diversifying, not rebalancing at least once a year, borrowing from the plan to pay off other debts, not rolling over the plan to an IRA after switching jobs, and on it goes. If I must pick one, I think the biggest mistake is not maximizing contributions at the earliest possible time to take full advantage of the compounding and tax savings.

George Papadopoulos (@feeonlyplanner) is a fee-only wealth manager in Novi, Mich., serving affluent individuals and families.

Christian Magoon: Apathy Is Not the Answer

401(k)s are often treated as second-class citizens by investors when it comes to monitoring performance, fees and asset allocation. This might be explained by the fairly painless contributions that workers make to 401(k)s or the mind set that accessing 401(k) funds is years, if not decades, away. Whatever the case, many investors allow apathy to be the primary investment strategy in these retirement engines. Sadly, for many workers 401(k) assets will be the primary source of income in their golden years.

Christian Magoon (@ChristianMagoon) is founder and chief executive of YieldShares, an income-focused ETF sponsor.

Rafael Pardo: Capture the Full Benefits of Your Employer's Matching Contribution

People often make the mistake of failing to contribute the amount required to trigger the maximum amount of matching contributions that their employer will make to their 401(k) retirement accounts. Many employers will match an employee's 401(k) contributions up to a certain percentage of the employee's regular salary in stepwise increments. For example, consider an employer whose retirement plan provides that the employer will match up to 5% of the employee's regular salary in the following manner: By matching with a 2.5% contribution for the first 2.5% of regular salary contributed by the employee and by matching with another 2.5% contribution for the second 2.5% of regular salary contributed by the employee. Based on this example, an employee who contributes 2% of regular salary would fail to trigger any matching contribution by the employer. And an employee who contributes 4% of regular salary would trigger only a 2.5% matching contribution by the employer. By failing to contribute more, both employees end up leaving a significant amount of money on the table: As I've previously written in this column, harnessing the power of compounding is critical to having sufficient retirement savings. If you don't capitalize on the full extent of your employer's matching contribution, you make the journey toward retirement security more of an uphill climb than it needs to be.

Rafael Pardo (@bankruptcyprof) is the Robert T. Thompson Professor of Law at Emory University, where he specializes in bankruptcy and commercial law.

Greg McBride: What Seems Safe Is Risky

People don't save enough and don't invest aggressively enough in their retirement savings. Investing too conservatively compounds the problem of not saving enough because the meager savings will not grow into a sufficient nest egg when hunkering down in conservative, low-return investments. Over the long haul, what is considered safe—cash and bonds—is actually quite risky, while what is considered risky—equities—is actually a much safer bet to get you to your long-range financial goals. Especially for young people, it is urgent to harness the power of compounding provided by higher return investments. But even those on the cusp of retirement may need this money to last a quarter century or more, so a healthy allocation to equities is warranted.

Greg McBride (@BankrateGreg) is a senior financial analyst and vice president for Bankrate.com, providing analysis and advice on personal finance.

Michelle Perry Higgins: Hands Off That Account!

What is the biggest mistake people make with their 401(k)s? Tapping into their funds today, thinking they won't need them tomorrow. I've seen so many people try to rationalize that pulling out retirement funds to meet immediate pressing needs is OK. I completely understand how challenging it is for Americans to pay their bills on a monthly basis. Everything from the mortgage to their children's sports activities is a drain on finances, and that makes things difficult. It can sometimes be easy to justify present wants as being more important than future needs. However, you must make your retirement savings a priority and don't procrastinate in adding to your 401(k) account. Most importantly, do not withdraw your retirement savings until you are well into your golden years. If you can do that, I promise that you will thank me later.

Michelle Perry Higgins (@RetirementMPH) is a financial planner and principal at California Financial Advisors.

Matt Hougan: The Secret's In the Saving

Mistake 1: Not saving enough.

Mistake 2: Being too conservative (you probably need more equity exposure than you think).

Mistake 3: Having a concentrated position in company stock. (Your job is tied to the company's success; isn't that enough?)

Mistake 4: Did I mention not saving enough? That's really the only mistake that matters.

Matt Hougan (@Matt_Hougan) is president of ETF analytics and global head of editorial for IndexUniverse LLC.

Charles Rotblut: No Second-Guessing

There is a large amount of evidence showing that people do not manage their 401(k) plans in a disciplined manner. Rather, they choose funds at the time they start the plan and then panic and sell those funds when they see a 401(k) statement during the midst of a bear market. Compounding matters is that many people do not even truly understand what they are investing in.

The reality is that with a little effort and discipline, a person with even nominal knowledge of investing can significantly increase the long-term performance of his 401(k) plan. Using an asset-allocation model from a reputable source (such as the one we have on AAII.com) can help you determine which asset classes you should be invested in. Then pick the lowest-cost funds for each asset class. Once a year, review your allocations and adjust your portfolio back to target if each fund's allocation has strayed five percentage points or more off target (e.g., your target large-cap stock allocation is 30%, but large-cap stocks now only account for 24% of your portfolio's value).

Alternatively, you can buy a target-date fund maturing near the year you turn 65 or 70. This fund handles all of the allocation decisions for you and is meant to be held into retirement. It may be more costly, but it requires less effort on your part.

Most importantly, do not second-guess your choices, especially during a bear market. The average holding period for a mutual fund is less than four years, according to research firm DALBAR. This short holding period causes the average equity-fund investor to realize a return about half of what they would have earned if they had just stayed invested and not second-guessed their decisions.

Charles Rotblut (@charlesrotblut) is a vice president with the American Association of Individual Investors.

Rick Ferri: Diversification Isn't Always the Answer

Oddly, 401(k) participants can be hurt by overdiversification. If a 401(k) plan has index funds, then they are the only investments needed in each asset class. If a plan doesn't have index funds, plan participants shouldn't overdiversify among several actively managed mutual funds within each asset class because this strategy actually lowers the probability for success.

In "A Case for Index Fund Portfolios," a newly released white paper I co-wrote, we show that a portfolio holding one actively managed fund in each asset class has a low probability of outperforming a similar portfolio holding only index funds. The odds get worse when an investor selects two or more actively managed funds in each asset class, which is often the case with participants in 401(k) plans. People do this because they believe they are diversifying their holdings, but this strategy actually lowers their probability for success.

The strategy with the highest probability for success is a portfolio of all index funds. However, if you don't have index funds in a 401(k) and must select from actively managed funds, then pick one actively managed fund per asset class and hope for the best.

Rick Ferri is founder of Portfolio Solutions LLC and the author of six books on low-cost index-fund and ETF investing. His blog is RickFerri.com.