Whether you’re fresh out of school starting your new job or just changing your employer’s a 401k is a great way to save for your future! Between the high contribution limits that you’re allowed to put away and employee matching, a 401k is one of the best tools when it comes to retirement planning.
Despite being mainstream, there are a lot of topics about your 401k that companies don’t want you to know about. This is the reason why it’s important to do your due diligence before just signing up for your 401k plan and start throwing money away.
Here are 4 of the most common pitfalls of 401k Plans:
1. Default Investment Option.
The default investment option is typically into what’s called a “Freedom Fund” or “Lifecycle Fund.” The issue with these is that they have higher fees than the other options in your 401k plan. It’s always smart to choose the mutual fund that meets your investment requirements and has a fee that is .25% or lower.
Not only are the fees higher, but the investment strategy for these default options provides you with automatic rebalancing. On the front end, this sounds like a good thing! Especially if you don’t have time to watch your investments on a daily basis.
The concern here is that your investment may adjust during periods of time where you don’t want them to and that may be detrimental to your wealth.
2. Your Employer Doesn’t Match.
If your employer matches ANY portion of your 401k contribution, it would be silly not to take advantage of the free money they’re giving you! If your employer isn’t matching your contributions, then it may be in your best interest to consider other ways to save money for retirement.
However, if you’re looking to put more money than the allotted amounts for IRA accounts which is about 6 to 7 thousand dollars then you definitely can consider utilizing your 401k to sock money away.
3. Limited Investment Options
401k’s are great for accumulating wealth and they’re what most investors use. But, one area where they are lagging is the number of investment options they allow you to put your money into.
An updated study from BrightScope and the Investment Company Institute (ICI) found that in 2016, the average large 401k plan contained 27 investment options, including a mix of equity, bond, and target-date funds.
Now, 27 investment options may seem like a lot, especially if you’re new to investing. But, when you consider there are thousands of investment options, do you really want to limit your choices to only 27 of them?
4. No Loss Prevention Strategies.
Unlike the other investment accounts out there in the world, 401k accounts don’t allow you to take advantage of loss prevention strategies. These strategies are called, Stop & Limit orders, which allow you to place onto your investments just in case the markets go up/down to levels you’re not comfortable with.
The one investment that is in all 401k plans is something called a Stable Value Fund, which allows your money to accumulate interest and not be susceptible to the rollercoaster ride that we call the Stock Market.
The pitfall with utilizing that fund is that you need to manually place the orders when you want to get your money back into the markets. This can cause you to “Time the Market” which is something you definitely want to avoid as an investor.
When it’s all said and done, a 401k is a great way to save and invest money! Just be cognizant of the pros and cons so that you can avoid making the same mistakes as your peers when it comes to protecting and growing your wealth!
Joshua Krafchick, AKA “Unconventional Money Guy”
Additional Reading to learn about Retirement.
1. What to Sell When You Need Money?
2. When to Use Your 401k Stable Value Fund.