You’re maxing out your company’s match in your 401(k), so that will eventually help fund your retirement, right? It might; it might not.
Contributing consistently to your 401(k) and receiving the full match are great beginning points for funding a better retirement. But taking these actions alone might not be enough — especially if you are leaving money on the table with a few common 401(k) mistakes.
Make sure that is not happening with a fast self-check against the three common 401(k) missteps below.
1. Contributing less than 10%
A contribution rate that is lower than 10% might not cut it, even if you are maxing out the company match.
Say you make an avg. salary of $52,520. A 10% contribution equates to roughly to $438 per month. If you are also earning a 4% contribution match, that adds up to $175 — for a grand total of $613 per month. It takes an entire 35 years of those contributions to build up to $1 million, assuming your avg. growth rate is about 7%.
If you have 35 years to wait and your lifestyle does not change drastically, having a $1 million nest egg and Social Security will fund a more than comfortable retirement lifestyle.
However, there isn’t a lot of room for error with this plan. A contribution rate that is lower than 10% would not be enough if retirement is under 35 years away. It is also not enough if you have to take some time off work or have to put a pause on your retirement contributions to, say, open a business of your own.
2. Choosing 401(k) funds that are based on history
No doubt you have seen the disclaimer on the fund documentation: Past results don’t predict future returns. Many investors will still move toward funds that have done well in the past.
Unfortunately, this backward-looking technique can be very unreliable. For instance, a niche fund may have done well last year due to world events that will not recur. The same fund can easily fall faster and harder than your other fund choices in the coming months.
You are better off reviewing the investment funds objectives and the expense ratio. The investment objective is what the investment fund is attempting to accomplish. That is the context you will need to evaluate past performances and whether the fund is a good fit into your retirement plan.
3. Over-diversifying
If your 401(k) has a piece of every fund in it, you are over-diversified. Over-diversification could produce minimal returns or higher volatility — two outcomes you should want to stay away from.
Most retirement savers should have only one or two positions within their 401(k). You could hold one target date fund by itself. Or, you could hold a large-cap index fund with a government bond fund. You could get more complicated if you were familiar with investing — but you do not have to.
An easier path to retirement
Correcting these few 401(k) mistakes could give you a little nice push toward a comfortable retirement. Contributing more now will provide wiggle room for anything unexpected going forward.
At the end of the day, investing more money at a risk level that is acceptable is what you need to achieve your retirement goals.
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