How to avoid 401(k) investing pitfalls

August 20, 2010

Why do some 401(k) portfolios perform better than others?

Key Points

One such error is investing too heavily in an employer's stock. Your paycheck already depends on your employer's financial performance, so don't make your retirement account too dependent on it as well. Allocating up to 5 percent of your portfolio is usually reasonable, assuming the stock's valuation is justified.

CONTROL RISK

The longer you have to go before retirement, the more you should allocate to stocks, because they have historically provided the highest long-term return. But because stocks can be risky over the short term, you should balance that risk by including bonds and bond funds in your portfolio. They tend to rise in value when stocks fall.

TIMING IS KEY

Another mistake is selling when everything is on sale, and buying when the sale is over-selling low and buying high. Over the 10-year period ending December 31, 2009, mutual fund investors realized an asset-weighted return of 1.7 percent versus the mutual funds' actual return of 3.2 percent. The main difference in returns was the investors' poor timing in buying and selling.

You can avoid mistakes in timing by making the same dollar contribution to your account at regular intervals-dollar-cost averaging. When markets dip, the same contribution will buy more shares of your investments.

CONSIDER PROFESSIONAL ADVICE

Professional advice can improve the performance of 401(k) portfolios, as was seen in the results of a study of 400,000 401(k) participants published earlier this year. The study, which covered the period January 1, 2006, to December 31, 2008, compared the results of those who sought professional guidance about their investments with those who did not.

On average, the median annual return for participants who did not seek help was about 4 percent, versus close to 6 percent (net of fees) for participants who did get help-a difference of 2 percent.

Although 2 percent may not seem like a big difference, consider the effects of compounding over the long term. If two investors each make a lump sum contribution of $10,000 at age 25, by the time they are ready to retire 40 years later, the investor earning 6 percent will have more than twice as much ($106,000 versus $52,100) as the investor earning 4 percent.

DUE DILIGENCE IMPORTANT

If you decide to seek help from a professional adviser, do your due diligence. Ask about his or her education and training, areas of expertise, and whether he or she accepts fiduciary responsibility for clients. Search engines such as Google and Yahoo are excellent sources of information about advisers.

With or without an adviser, you should review your portfolio at least twice a year, and when necessary, rebalance it to maintain the appropriate risk level. With a little homework, you can avoid common 401(k) pitfalls and enhance your long-term financial security.

The author is chief executive officer of Skloff Financial Group, a registered investment advisory firm based in Berkeley Heights, New Jersey. The ideas expressed in this column are his alone and do not represent the views of Medical Economics. If you have a comment or a topic you would like to see covered here, please email medec@advanstar.com
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