While company retirement plans often have guardrails, investors can goof with contributions, investment selections, loans, and withdrawals.
By Christine Benz | 02-24-15 | 06:00 AM | Email Article

Note: This article is part of Morningstar's February 2015 Tax Relief Week special report.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

A company retirement plan--whether a 401(k), 403(b), or 457 plan--is the starter savings vehicle for many investors, so it's probably not surprising that the plans usually have more guardrails than other investment vehicles. 

Company-retirement-plan menus typically feature plain-vanilla stock and bond funds to keep plan participants from gorging on exotic investment choices, and participants are often opted into age-appropriate target-date fund vehicles. And because 401(k) participants are often extremely hands-off, many plans offer features such as automatic rebalancing and automatic escalation to increase contributions as participants' salaries grow. 

Yet, not all plans include such safety features, and 401(k) menus aren't universally high quality. Plans offered by small employers may be larded with extra administrative fees or high-cost funds, and their lineups may skimp on core asset classes such as international equity or fixed income. Participants can also run into unforced errors--for example, not paying enough attention to asset allocation when making their investment selection, or cashing out their money when they change jobs. 

In short, 401(k) plans invite the potential for plenty of goofs. Here are 20 common ones, as well as tips on avoiding those mistakes. (Note that in the interest of brevity, I'll use "401(k)" as a shorthand for all company retirement plans throughout this article, but the points apply to 403(b)s and 457 plans as well.) 

1) Not Considering Asset Allocation Before Making Investment Choices 
When making investment selections, 401(k) participants are typically confronted with a menu of individual fund choices. The importance of setting an age- and situation-appropriate stock/bond mix never even comes up, even though that will be the biggest determinant of how the portfolio behaves. Setting an appropriate asset-allocation mix is more art than science, but target-date funds or benchmarks like Morningstar's Lifetime Allocation Indexes can be a good starting point. This article provides some pointers on arriving at a sensible asset-allocation mix. 

2) Not Investing Differently If Your Situation Is an Outlier 
Target-date funds are often the default options in 401(k) plans, and they're valuable in that they can help investors set their asset allocations and monitor them on an ongoing basis. Even investors who don't intend to invest in a target-date fund can use them to help determine an age-appropriate investment mix. That said, the allocations embedded in target-date funds won't be right for everyone, especially for people with substantial "assets" outside their 401(k) plans. For example, individuals who will be able to rely on pensions to cover most of their in-retirement expenses will likely want a more aggressive asset allocation than would be the case for generic target-date funds. (For this reason, some employers use custom target-date funds, tailored to the situations of their plan participants.) This article provides tips for customizing your asset-allocation mix. 

3) Not Factoring in Other Assets When Making Investment Selections 
For investors who have been working and investing for a while--or those with spouses who hold their own investment accounts--their 401(k) plans may be but a small piece of their overall assets. In that case, it's wise to factor in all of the retirement assets when determining how to allocate the 401(k). Morningstar's X-Ray function can help investors see the composition of their total portfolios across accounts; they can then use their 401(k) plan assets to help steer the total portfolio toward their desired asset-allocation mix. 

4) Focusing Too Much on Past Returns When Making Investment Choices 
In addition to not getting much coaching on their asset allocations, many 401(k) participants are given a limited amount of information about the investment choices on their plans' menus. They may see a fund's asset class or category, as well as its returns over a certain time period, such as the past five years. Is it any wonder so many novice investors simply reach for the funds with the highest numbers? Of course, that's not a recipe for great investment results, as those high performers often revert to the mean. Rather than chasing the hottest performers, investors are better off focusing on fundamental information about funds' strategies, management, and expenses to help populate their asset-allocation mixes. Morningstar's qualitative Analyst Ratings attempt to pull all of these considerations together into a single forward-looking measure. 

5) Venturing Into the Brokerage Window Without Paying Attention to Transaction Costs 
If investors do their homework on the fund options on their 401(k) menu and find them wanting, the ability to invest via a brokerage window might appear to be a godsend. Such windows typically give participants many more choices than they have on the preset menu, including the ability to invest in individual stocks and exchange-traded funds. The big downside, however, is that participants will typically incur transaction costs to buy and sell securities within the brokerage window. Those trading costs can drag on returns, especially for investors who are making frequent small purchases. 

6) Avoiding No-Name Funds 
Company-retirement-plan menus are often populated with funds from the big shops--Vanguard, Fidelity, T. Rowe Price, and American Funds. But plans may also include less-familiar names, often collective investment trusts that are explicitly managed for retirement plans. Although information may be less widely available on some of these options than is the case for conventional mutual funds, their expenses may be low and their quality may be good. This article provides some pointers for researching collective trusts and other non-name-brand options that might appear inside your 401(k). 

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