Mistakes that Can Derail 401k Planning

Personal responsibility is a hallmark of 401k planning. So are personal mistakes. We all know that a market crash, job loss and other outside factors can wreak havoc on a 401k. But equally damaging are personal behavior obstacles that can get in the way of executing a retirement plan. These are behaviors totally within your control – if effectively recognized and dealt with. Here are some examples:

1. Procrastination and Inertia – It is human nature to put off doing things we don’t like, things we don’t feel comfortable doing or things we don’t fully understand. But in the world of 401k’s time really is money and procrastinating on actions like enrolling in your 401k, bumping up contributions, or reviewing and adjusting your investment mix can be costly indeed. Remedy: Just Do It! The cost of inaction is too severe as the following example shows:

	Mike	Bob
Starting Age	27	30
Annual Amount	$2,000	$2,000
Annual Return	8%	8%
Retirement Nestegg @65	$477,882	$374,204

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Mike and Bob following the same retirement investment program with the only difference being that Mike got a 3-year head start. End result: The additional $6,000 dollars that Mike saved in the first three years becomes a $103,678 retirement savings advantage at age 65.

2. Information Overload – A big reason people procrastinate is that they feel overwhelmed with too much data and too many choices. This is especially true in the realm of investing. Some 401k plans offer participants dozens of investment funds to choose from. Result? Studies show that the more investment options offered, the more likely participants are 1) not to participate in the 401k and, 2) opt for “safe” bond or money-market funds if they do participate. Remedy: Keep things simple and stick with low-cost index mutual funds that mimic overall market performance. Research consistently shows indexing to be the best long-term 401k investment portfolio strategy.
3. Too Much Focus on the Short-Term – Too often 401k participants “buy high” and “sell low”. When markets tumble and things are at their gloomiest, individuals have had enough and opt to get out. Conversely, they often jump in when markets are riding high and news is favorable. (One study by Hewitt Associates showed that, in 2008, 9 of the 10 most active trading days for 401k participants occurred the day after a large market downturn.) Remedy: Again, keep things simple and understand that attempts to time the market almost always fail. Stick with a consistent “dollar-cost averaging” approach. This allows more shares to be purchased when prices are low and fewer shares to be purchased when prices are high. The overall result is a lower average cost per share.
4. Too Much Focus on Lump Sums – The single greatest risk that people face in retirement is longevity risk – i.e. outliving one’s assets. A study by McKinsey & Company projects that 1 in 5 retirees will live at least until 90, but run out of money at age 85. Yet the overwhelming majority of 401k participants opt to withdraw assets on their own schedule (often in a single lump sum), and only rarely convert them to a guaranteed lifetime annuity. One study found 3 out of 5 people were willing to exchange part of the guaranteed Social Security annuity for an immediate lump-sum of approximately equal actuarial value. Remedy: Do not let the general preference for lump sums over annuitized distributions drive your decisions. Take time to study the annuity option. Securing a guaranteed income stream for life may be you best defense against longevity risk.