Are you blindly throwing money into your retirement accounts every month? That’s probably not the best plan.
Yep, I used to do that too. I pretty much used the “set it and forget it” approach to my 401(k). After making my initial investment selections, I barely thought about it again – except for checking in on its total value a few times a year. I mean, you should leave everything to the professionals, right?
While messing too much with you retirement can kill your returns, not paying enough attention can destroy them too. But, in some cases, doing the right thing may take a little more effort on your part. Here are 7 ways you may be killing your 401(k) returns without even knowing it.
1) Paying High Fees
Financial salespeople love to say the average stock market return over is about 10%. That’s a nice sales pitch but it isn’t quite accurate. A better metric for determining returns is the compound annual growth rate. Since 1900, CAGR for the S&P 500 stands between 6.5% and 7%. I may not be Donald Trump, but I know that’s a HUGE difference. Additionally, 81% to 96% of actively managed funds fail to beat the S&P 500 benchmark… and since actively managed funds charge higher fees than low-cost index funds, you’re essentially paying more for inferior results. What’s worse, you don’t just lose on fees; a typical fee of 3.5% wipes out over half of your returns too. That could literally cost you hundreds of thousands of dollars (or more) in retirement savings.
The Fix: Before you do anything, create a free account and use this calculator to determine what you’re paying in fees. After using the calculator, we decided to start saving some of our retirement funds in low-cost index funds through Vanguard. Depending on your situation, putting part of your retirement savings into a Roth or Traditional IRA using low-cost index funds might work for you too.
2) You’re Not Meeting Your Company Match
I’m not saying you shouldn’t be saving in your work-sponsored retirement plan. You almost certainly should, especially if your company offers matching funds. Bring the 401(k) fees to your employer’s attention, but still use these accounts if they are matching your contributions. That’s still FREE money, and who doesn’t want that?
The Fix: Save at least enough to meet your company’s full match. So, if that’s 4% of your salary, you need to save at least 4%. Depending on the type of retirement account offered, this may also make you eligible to receive profit-sharing. (Yay! More free money!)
3) You’re Not Saving Enough
Whether you’re using an employer-sponsored retirement plan, a self-driven retirement plan, or a combination of both, be sure you’re putting enough money away for retirement. Don’t just pick a number they think they can afford and say, “Yep, that ought to be enough.” Maybe it is… maybe it isn’t. Worse, you may not be adjusting that number as your salary increases.
The Fix: Use any number of free financial tools to determine what your savings rate should be. Here’s a good rule of thumb: At a minimum, save at least 10% of your income for retirement. If you got started late, are self-employed, or want to retire early, you’ll need to save more. (Personally, we shoot for 15-20% every year.) Instead of having a flat fee deducted from your paycheck, use a percentage of your income instead. That way, every time you get a raise, your retirement savings gets a boost as well.
4) Waiting to Invest
Maybe you’re young and think you have all the time in the world to invest. You’re wrong, and your procrastination could be costing you tens of thousands of dollars. It could also mean you’ll have to work several additional years before you can retire.
The Fix: When it comes to your retirement accounts, time is your best friend. Compound interest plays a huge part in the success of your retirement funds, and its biggest effect is felt the last few years before you retire. Don’t waste your youth. Take advantage of the time you have by investing as early and as often as you can.
5) You Panic
You’ve checked your fees. You’re meeting your company match. At least 10% of your income is being saved for retirement. But then the market starts to go down. You panic, claim the market is rigged, and rush to sell off your securities. Instead of riding out the storm, you move your funds to a “safer” alternative. Of course, you’ve just cost yourself lots of money.
The Fix: Everybody feels like a genius when the market is up, but it’s hard not to get nervous when the market starts tanking. Ride it out. Remember, you don’t realize a loss until you sell those shares for less than what you paid. While past performance isn’t indicative of future results, the market has always gone back up. It may take a while, but in the meantime, you’ll be able to buy stocks at a discount. Stick with the plan, keep putting money in, and use what’s called “dollar-cost averaging.” That means, you’ll keep putting in the same amount at the same intervals. The idea is your purchases in a down market will offset the purchases when markets are high, leaving less room for emotional mistakes and resulting in a lower cost-per-share over time.
6) Your Asset Allocation Stinks
Asset allocation is the key to making the most of your retirement funds. Unfortunately, too many of us fail to understand its importance. Many of us simply set up our retirement accounts and never bother to check on them again. As parts of our portfolio grow, we may be saving far more in certain areas than we ever intended. Additionally, our asset allocation and tolerance for risk should change over time. Your age and time horizon until retirement should have a big influence on where you’re investing your money.
The Fix: Be sure to look at your investments at least once every year. Search for areas where your target asset allocation may be out of whack. Then, rebalance your funds to ensure you’re in line with your investment goals. Again, you can use a free investment checkup tool to see where you’re at and provide suggestions.
7) Using Your Retirement Account as a Bank
What if you’re stuck and need some quick cash to pay bills? Should you borrow against your 401(k) or your Traditional IRA? No. No, you shouldn’t. Although you can take out interest-free short-term loans, this could have huge consequences for your retirement. First, you’ll have to pay back the loan with after-tax money. So, depending on your tax bracket, you’ll probably pay around 15% to 28% more than what you took out. Failure to pay it back on time could mean paying income tax on the amount you withdrew… plus they’ll tack on a 10% penalty just for fun. Ouch. Not to mention, by failing to repay the loan, you could lose out on thousands of dollars worth of growth.
The Fix: Look, I advocate saving cash for things you need or using your emergency fund to handle unexpected expenses. However, if you are in desperate need of a loan, don’t borrow from your 401(k). Try a personal loan instead.
Even if you think you’re doing the right thing, paying some attention to your retirement funds can save you tens of thousands of dollars. I hope these tips have opened your eyes and given you some food for thought. So, go out and put your investments to the test. Good luck and report back in the comments below!