The 5 biggest 401(k) mistakes

Mistake No. 3: Seeking 'safety'

"Pat63" laments his lousy choices: "Since there are savings accounts available that earn 4.5%, I'm curious as to why there are no similar accounts for IRA or 401(k) rollover amounts that would alleviate anxiety, instead of everyone being herded to investing, which is gambling with one's future no matter what it is called."

Actually, pension-plan savings accounts, usually called stable value, are one of the most popular 401(k) options. They are also the very worst. For one thing, they don't pay money market interest rates; the one in my wife's plan is currently paying 3%. These are, after all, crummy, expensive insurance-company products.

The inflation rate is about 3%, so in terms of purchasing power, you just break even. And when you take the money out in retirement, it is taxed, so you lose perhaps 20% of your purchasing power.

Pat is right about one thing: Putting money into stable-value accounts isn't gambling. Gambling gives you a chance to win. You can't win with these things. You can manage investment risk, but you can't avoid inflation and taxation. Save instead of invest and, unless you started as a millionaire, you will die broke.

Mistake No. 4: Blindly following conventional wisdom

There are many truths in investing, one of which is, "Don't chase performance." It's a great rule of thumb because that which is most hot is most apt to turn cold. But it presumes you know how to use a thumb.

For example, I pointed out in my column last week ("4 ways to recession-proof a 401(k)") that bear market funds do well in a bear market. To illustrate this revolutionary insight, I cited UltraShort MSCI EAFE Index ProShares (EFU, news, msgs). It is designed to go up twice as much as the key foreign-stock index goes down. At the time, it was up 22.7% in less than three months. In the two trading sessions after that column appeared, it spurted 6.8% more.

A poster named "Crashnburn5990" writes: "I have looked at inverse (ProShares) funds and am holding off on buying them just yet. For the most part, they have just spiked, and I am really (leery) of buying a fund that has just spiked. I'd much rather buy a fund that has apparently bottomed out and is just passing through its 50-day simple moving average."

D'oh! If you wait for this fund to bottom, the bear market will be over, Homer. And that won't be a great time to buy a bear market fund.

Mistake No. 5: Timing a market meltdown

Over at Start Investing, "Gator Trader" has got this thing figured out. "Wait for (the market) to bottom," he advises. "I think that would be the easy way out and seems like the right thing to do. There is a bottom, and we are about six months out. Why six months? Because that is about how long it will take for the recent moves to mature."

I would love to call the bottom, too, but I can't. Neither can anybody else. The recession-induced bear market of 1990, which produced losses of about the same magnitude as this downturn has so far, lasted little more than three months. But the recession-induced bear market of 2000 got twice as bad as what we've seen in this pullback, and it lasted two and a half years.

(And what if we're not in a recession? According to research by Hussman Funds, bear markets not related to recessions last an average of 215 days, compared with 491 days for recession-induced bears.)

"Capitaloss" has a 401(k) plan that allows him to invest 100% of his annual contribution at the start of the year, and he asks, "Should I invest it all now or dollar-cost average over the first half of the year?"

I would take advantage of the plan's flexibility and put it all down today. Capitaloss is 37; putting down 100% on Day One of each new year is a form of dollar-cost averaging, which he can repeat for decades. Meanwhile, he puts money to work at the earliest possible moment, maximizing the benefits of compounding.

Most 401(k) participants contribute a portion of each paycheck, which is classic dollar-cost averaging. But if you have flexibility, such as with individual retirement accounts, lump-sum investing produces higher returns two-thirds of the time. So plan ahead: Instead of funding your 2008 IRA on April 15, 2009, fund it today and give yourself an extra 15 months of tax-deferred compounding. Plus, the odds are greater than 50% that stock funds are cheaper today than they will be in 15 months.

It's too bad most American workers know too little about investing to take full advantage of their 401(k)s. It doesn't take a lot of effort. Mostly it takes confidence, and confidence comes with experience. Bear markets are painful for seasoned investors, but they are not alarming. They come like winter, and like winter they must -- and do -- depart.

Meet Middleton at The Money Show

MSN Money mutual funds expert Tim Middleton will be among the more than 50 investing experts gathered in the nation’s capital for the 4^th annual Money Show Washington D.C., from Nov. 6-8, 2008. Just days after the election, this elite group will present more than 170 free workshops to help you prepare yourself for the new political landscape. Admission is free for MSN Money users. Call (800) 970-4355 and mention priority code 009553, or visit The Money Show Washington D.C. Web site to register free today!

At the time of publication, Tim Middleton owned the following securities mentioned in this article: UltraShort MSCI EAFE Index ProShares.

< previous |  1 | 2 |