One of the best ways to save for your future is with a tax-advantaged retirement plan offered through your employer. Many employers offer access to 401(k) plans. You can receive tax advantages that include deductions or tax-free investment earnings.
Unfortunately, not all 401(k) plans offer you exactly what you need in terms of investments and low costs. The wrong setup for your retirement portfolio could mean thousands of dollars lost for your retirement. Here are some of the 401(k) pitfalls that can lead to an under-performing portfolio:
High Plan Costs
All retirement plans come with costs. The administration costs associated with a retirement plan have to be considered. It’s common to pay at least 1% annually in plan costs. This may not seem like a lot, but eventually it adds up over time. If you pay 1% on $10,000, that’s $100 a year. Not a great deal, but consider what happens as your retirement savings grow. If you are diligent and grow your nest egg to $500,000, now you’re looking at $5,000 a year in plan fees. And if your plan fees are 2% or higher, the situation is even more dire.
Once you save up enough money that the yearly fee is starting to drag on your returns in a significant manner, consider rolling over to an IRA. The costs are usually lower, so you don’t have to worry about the erosion of your returns due to high fees.
High Fund Costs
Not only do you have to worry about the fees that come with the plans, but you also need to be concerned about the fees that come with the funds offered by the plan. Many 401(k) plans offered by employers feature high-cost funds. These high expense ratios can be anywhere between 0.90% and more than 2% a year. This only compounds your fee problem.
Look for funds with low expense ratios. Index funds and ETFs often have fairly low expense ratios, so they can limit your costs. And, if your only options are high cost funds, consider rolling over to an IRA that allows you invest in your preferred low cost funds.
Limited Investment Choices
Some employer sponsored plans are rather limited in their offerings. This means that you might not be able to invest in the securities you prefer. Be especially wary if your options are so limited that company stock starts to take over your retirement portfolio. You need your choices to allow you some diversity in your retirement portfolio, as well as provide you with access to low cost options. And never put all your retirement eggs in the company stock basket.
Too Many Investment Choices
Rather than being stymied by a lack of investment choices, some 401(k) plans have too many investment choices. As a result of all these choices, some workers become intimidated and avoid making major decisions with their money. Instead, cash products are used for the retirement portfolio. Unfortunately, you are unlikely to be able to achieve the return needed for a secure retirement if you rely on cash products.
Don’t become overwhelmed with the investment choices. Identify two or three index funds or ETFs that make sense for your portfolio, and then invest in those.
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I like this approach. I am invested in a large cap, a small cap, and an international fund. It is aggressive but diversified.