The 5 biggest 401(k) mistakes

By Tim Middleton

If you're worried about your 401(k), you have a lot of company. Our Start Investing community has a thread titled "Are you getting enough from your 401(k)?" It has attracted roughly 50 times more interest than any other discussion on that message board.

Many of the message-board posts are along the lines of this one, from a member called "Truns": "Sure, I'm worried. Should I wait it out?" (Short answer: Yes. The long answer follows.)

A great many posts convey the alarm and frustration of folks who are scared to death by something they don't understand. Believe me, once you understand investing, it isn't that scary.

"Phil5185," one contributor who knows the subject inside out, wryly notes, "Stocks seem to be the only thing that people hate to buy on sale."

In the testimony of participants on this thread, I've discovered five of the biggest mistakes a 401(k) investor can make. Postings are anonymous (except mine), so I don't think I'll embarrass anyone by sharing these errors with you.

Avoiding them can make you rich. Phil says he participated in his plan for less than 20 years and never got a company match, yet he managed to amass $1 million. "Young people with 30 or 40 years will have some awesome 401(k)s," he says.

Mistake No. 1: Selling when it's time to buy

A 27-year-old identified as "Lucky4jar" complains, "I have been putting more and more money in every two weeks only to watch my total go down and down." His solution: "I have since lowered my contribution rate from 15% to 3%, enough to still get the company match."

It was this post that attracted Phil's retort about stocks being on sale. A bear market is not the worst time to buy stocks; it's the best time. Markets lurch between periods of excessive optimism (the bull phase) and mind-numbing dread (the bear phase). The latter periods correct the excesses of the former, but then they, too, go to extremes.

Over a lifetime of investing you'll go through a dozen of these cycles, and you'll discover the bear phase is when you make your real money, because that's when you pay the least for the best stuff.

Every month my wife and I make contributions to our brokerage and retirement accounts, and except for a portion of our emergency savings, 100% of that goes into stock mutual funds and exchange-traded funds -- and mostly the risky stuff, such as midcap and emerging-market funds.

Mistake No. 2: Trying to 'recoup' your losses

Contributor "Masta Purba" is planning to leave her job. She writes, "I have a dilemma: whether to leave the retirement money in the 403(b) account with my current employer for a little bit longer, until I recoup the loss, and then roll it over to IRA, or should I reallocate all the money NOW? (That means I have to sell low and will not have a chance to recoup the loss that has already happened.)"

A field of psychology called behavioral finance was created to deal with issues like this. It turns out that -- surprise! -- people hate to lose money. So one defense we unconsciously deploy is to defer acknowledging losses by vowing to recoup them. If you get back to even, that's proof you didn't make a mistake in the first place, right? You don't look so dumb.

But hanging on can be even dumber. Stop and think about it: Your investments are worth today's price today. All investments are. Markets go up and down together. You will recoup when the market -- the whole market -- goes back up.

Masta Purba realizes her company plan is unnecessarily costly, as are most 403(b)s. These are the versions of 401(k)s for teachers and other employees of not-for-profit institutions, and nearly all of them are expensive insurance-company programs. She is thinking about moving her money to Vanguard or T. Rowe Price, both outstanding and economical investment managers.

My advice: Do it immediately. These better managers will lose less of her money, and the lower costs will leave more dollars in her account, not theirs.

Continued: Seeking 'safety'

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