If you have designs on achieving the retirement you desire, then don’t act the typical 401(k) investor.
Many veteran workers are making many rookie investment mistakes with their employer-sponsored retirement plans, be they 401(k), 403(b), 457 or similar plans. What are those mistakes and what might you do to correct or to avoid them before they sabotage your retirement?
1. Know your investments
You might think that Americans who participate in an employer-sponsored retirement would be familiar with the investment options in their plan. Well, think again. Apparently, one in three of Americans participating in a 401(k) or similar plan are unfamiliar with their investment options, according to a survey by TIAA-CREF.
Why might you want to take a moment to learn about your investments? Well, apparently, there’s a correlation you might want to consider: People who are familiar with their investment options are almost twice as likely save at least 10% to 15% of annual income for retirement. And saving that much, my friends, will go a long way toward helping you have a comfortable and secure retirement.
“To get there, it’s critically important for people to understand all of the investment options in their retirement plan, and how those options will translate to income in their retirement,” Teresa Hassara, executive vice president of TIAA-CREF’s institutional business, said in a release.
Read the executive summary of TIAA-CREF’s survey .
2. Know your fees
In 2012, the Dept. of Labor issued final regulations requiring the disclosure of fee and expense information to defined contribution plan participants and sponsors. The intent was to provide greater transparency and awareness to the costs of providing and participating in an employer-sponsored retirement plan, according to a recent LIMRA Secure Retirement Institute (SRI) report.
Unfortunately, what seemed like a good idea on paper didn’t really work in reality. In fact, research suggests these disclosure rules have had little effect on participants’ knowledge of them.
Consider: Since July 2012, the SRI has conducted a series of consumer surveys asking defined-contribution plan participants about their retirement plan fees. Its 2012 survey, conducted prior to the initial participant disclosure, showed that 50% of retirement plan participants do not know how much they pay in fees and expenses.
One year later, a follow-up survey tells the same story. The disclosures have had little impact as there is no noticeable difference in participant knowledge of the fees they pay, SRI wrote.
Meanwhile, the SRI’s 2013 findings show that half of participants do not currently know how much they pay in fees and expenses. Further, nearly four in 10 still believe that they do not pay any fees or expenses. One-third of plan participants believe they pay more than 10% in total plan fees. And only 12% of defined contribution plan participants were able to estimate a percentage.
So, if you don’t want to behave like the typical 401(k) investor, get a handle on your investment and plan fees. By way of background, participants in 401(k) plans often get hit two ways. First, they pay to cover the annual operating expense of the plan and they also are charged for the expenses associated with the mutual funds they hold, according to a BenefitsPro report.
Read the Labor Dept.’s A Look At 401(k) Plan Fees . Also read “Much” Ado – Shedding some light on your workplace retirement plan fees and Making the Most of your Retirement Plan
Need some motivation to do a deep dive on your 401(k) fees? Consider this: The Securities and Exchange Commission is concerned that investors may not understand the significant impact fees can have on their long-term on returns. “Fees may seem small, but over time they can have a major impact on your investment portfolio,” the SEC bulletin said. Read Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio .
3. Contribute to the match and then some
Nearly one in three workers don’t take full advantage of the free money that their employer is trying to give them — the so-called employer match. According to a research conducted by AonHewitt in 2012, 32% of plan participants contribute at the match threshold and 40.5% contribute above the match threshold. However, 27.5% contribute below the company match threshold.
The average match, by the way, is generally 50 cents on the dollar, up to 6% of salary deferrals, according to Attila Toth, a partner with and co-founder of Portfolio Evaluations. “Often you find participants not contributing enough to receive the full match, or perhaps even stopping their deferral rates at 6% just to obtain the full match,” he said.
So, if nothing else, contribute enough to your plan to get the full employer match. If a participant leaves their contribution rate at 6%, plus the 3% match, this equates to 9% total savings, Toth notes.
That is not enough. In fact, you’ll likely have to contribute at least 15% if you want your future life to be like your current life, according to Toth.
But saving to the match if you’re below the threshold is a good start.
Of note, more retirement plan sponsors have begun offering employee matches over the past five years, according to research from Strategic Insight, an Asset Management company. Plan sponsors that match “50% to 99% of the first 6%” of salary rose to 58% in 2013 from 52% in 2009, according to the report. Plans also saw improvements to employer matching contributions, formulas, schedules and vesting.
4. Do a cost/benefit analysis
Most everyone believes it’s prudent, at least on paper, to diversify your investments in your 401(k) plan. In essence, you want to own investments that don’t always behave the same. If one investment goes down in value, you want another to rise in value. Portfolio diversification experts say this tactic tamps down the volatility of your portfolio and, with hope, improves its risk-adjusted performance.
But what works in academia doesn’t always work in a 401(k) plan, according to a new paper. Some 52% of retirement plans offer at least one fund “where the costs of fees in holding the fund so outweigh the benefits of additional diversification that rational investors wouldn’t invest in these assets,” wrote Ian Ayres of Yale University and Quinn Curtis of the University of Virginia School of Law, the co-authors of the report. Read Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’ in 401(k) Plans .
Also, keep in mind that many plan sponsors typically provide too many investment choices and that can have a detrimental effect on participants, according to Toth. Read The 401(k) Lineup: Successful Planning with a Focused Lineup .
5. Speaking of diversification …
And whatever you do, don’t own a target-date fund and then five or 10 other funds. Doing so defeats the purpose of owning a target-date fund, which typically contains more than a dozen funds and provides instant diversification.
If you want to own a target-date fund and other funds that might be offered by your 401(k) consider those funds or investments that duplicate the one you already own in your target-date fund. For instance, if your target-date fund doesn’t own a small-cap value fund, for instance, and it might make to sense to invest a small percentage of your 401(k) in that kind of fund, assuming your investment policy statement calls for that sort of investment.
6. Calculate how much you’ll need
Many people never take the time to project what their expenses will be in retirement. You should. People, according to new Stanford research, save more for retirement when they use detailed retirement income projections and information. Read Knowledge is power when it comes to retirement planning, Stanford researcher shows .
Don’t feel bad, by the way, if you haven’t crunched the numbers yet. Most don’t. “Workers often guess at how much they will need to accumulate (45%), rather than doing a systematic retirement-needs calculation,” according to the EBRI’s 2013 Retirement Confidence Survey: Perceived Savings Needs Outpace Reality for Many . “Eighteen percent indicated they did their own estimate and another 18% asked a financial adviser, while 8% used an online calculator and another 8% read or heard how much was needed.”
7. Don’t forget to participate
By the way, one last mistake to avoid is this: Don’t forget to defer a portion of your compensation in your employer-sponsored retirement plan. Right now, three in every 10 workers don’t even participate in their 401(k) plan.