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Avoiding Common Retirement Plan Mistakes

March 2010

Picking Stocks

Employer-sponsored retirement accounts can be one of the best savings tools around. Unfortunately, not all plans are created equal and even good plans can be a source of confusion. Don’t give up! Making the most of your old and current retirement savings plans is one of the best and wisest things you can do for yourself.

1. Choosing funds based on past performance rather than selecting a balanced mix of stock (large, small, US and international) and bond funds. A recent survey by Bankrate.com indicated that 30 percent of investors make their investment choices by picking the top perfoming funds for the last five years. But past mutual fund winners almost never repeat their winning performance. What matters most in long-term investing is getting the mix of assets right and keeping your investment costs as low as possible. When in doubt, review each broad category (for example, large US company stocks) and pick the fund with the lowest expense ratio or management fee in each category.

2. Letting short term events govern what should be a long term investment strategy. As my mentor, Nick Murray, says, “Bear markets are as common as dirt”: on average, the stock markets will take a tumble every five years or so and even bond markets can hurt unwary investors. Reacting in fear when markets are weak or with overconfidence when markets are strong is a normal human reaction, but it’s a sure way to hurt your long-term investment plan.

3. Picking too many funds. The average 401(k) plan offers a choice of over 19 different funds. This is far more than anyone needs and just adds to investor confusion. If you’re confused about the funds offered it’s easy to say, “I’ll try one of these and one of those.” You’ll end up with an indigestible plateful. How many funds are enough? See this article from last quarter’s newsletter.

4. Depending on target date funds. These funds start young investors off with a stock-heavy mix and automatically move investors towards a more bond-heavy “conservative mix” as they get older. It looks like a nice, simple idea, but it’s often a bad move. Too many target funds rely on flawed mathematical models that encourage too aggressive a mix of assets, with too much exposure to stocks even for younger investors. That’s a problem because watching your hard earned savings plunge 30 percent–50 percent (not unusual for a portfolio of mostly stocks) is discouraging even for brave young investors. Further, most people’s lives do not go smoothly, not everyone retires at 65 and many people need to tap their savings sooner than they expected. Dipping into a retirement plan early is not a great thing to do, but if medical expenses or other major emergencies hit it may be necessary. If the emergency coincides with one of those regular bear markets and your target plan has you mostly in stocks, you will be in trouble—forced to make withdrawals just when your savings are depleted. If you want a one-fund solution, a broad “balanced” fund might be a better choice.

5. Letting old 401(k) and 403(b) plans languish. I once worked with a client who had nearly two dozen old plans, most with balances less than $2,000. She had not opened a statement in years. That's a guaranteed way to pay lots of fees to money management companies and keep next to nothing for yourself. An even worse choice is liquidating a retirement account when you change jobs—yet that’s what 80 percent of Americans with small accounts do. Creating a rollover IRA and consolidating all those accounts can be a lot of work. If you are doing a rollover your old advisors will often put lots of obstacles in your path to discourage you from moving your money. The whole process can be remarkably time-consuming and paper-intensive, but do you really want to let the big money guys get away with this? Remember, the savings you can reap by avoiding low balance fees and expensive funds will reward your efforts handsomely. And if you do a rollover instead of cashing out you will avoid extremely steep tax penalties and reap the rewards of decades of tax-free growth. For more on consolidating accounts see this article.

6. Doing nothing. It’s so tempting to look at all these choices and all the confusing documents and all the work involved and fail to take any action at all or to start the process and then drop the whole thing once you hit the first wall. Nearly 30 percent of employees contribute nothing at all to their employer-sponsored plan even if their employer provides a match, and among younger workers who can benefit the most from saving, nearly 40 percent fail to contribute. That’s like passing up a stack of gold coins left on the sidewalk because it might be a little heavy to carry! Taking advantage of your current 401(k) or 403(b) plan (even if it’s not the best) and making the most of retirement money you’ve already put aside is one of the best and wisest things you can do for yourself. And it can be fun as well as financially rewarding, particularly if you work with a financial coach to guide you through the maze.

Responsible Investing provides one-on-one guidance that will help you make the most of your 401(k) plan, flaws and all. We can also help you learn how to use self-managed IRAs to supplement and complement a less-than-perfect employer sponsored plan. For corporations, we provide customized consultations that will help you select the best plan for your employees, as well as objective, independent education for human resources professionals and employees. Contact us for an appointment today.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Outside sources used in this article are believed but not guaranteed to be accurate. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.