7 ways to mess up your 401(k)

By Liz Pulliam Weston

In many ways, the 401(k) picture looks bright.

Most folks who have access to a 401(k) take advantage of their workplace retirement plans. Average balances are up over the past few years. And workers seem to have finally gotten the message that company stock is not their best investment option.

But millions of workers are still blowing it every day when dealing with their retirement plans. Here are the seven biggest blunders you can make:

1. Not signing up

I've seen a few awful 401(k) plans in my time. One was run by a dentist who forced his employees to help him buy raw land. (That was their only investment option.) Another offered only high-cost, poorly performing variable annuities with surrender charges that lasted 16 years, meaning workers often had to forfeit a good chunk of their money if they left their jobs and wanted to roll over their accounts.

But such truly heinous plans are few. Most participants get a decent range of investment options (17 choices is typical), reasonable fees and a company match. About 98% of the large-company plans that Hewitt Associates surveyed contribute to employee plans, with two-thirds offering matches.

There's simply no reason not to participate in a plan that's even halfway decent, yet one out of four eligible workers fail to sign up. Participation among young workers is even more dismal: Only 48% of those aged 20 to 29 are enrolled, according to Hewitt's survey of large plans. That's just dumb.

Average 401(k) account balances:

Age group*	1999	2006	Change
20s	$2,558	$28,248	1004%
30s	$17,277	$61,368	255%
40s	$50,147	$108,262	116%
50s	$82,059	$148,927	82%
60s	$121,982	$157,727	29%
All	$67,760	$121,202	79%

*Age of participant in 2006

Source: Employee Benefit Research Institute (September 2007 report)

2. Missing out on the full company match

The typical large-company plan matches 50% of your contributions, up to 6% of your salary, Hewitt reports. Your match may not be as generous, but it still makes sense to take maximum advantage of what essentially is free money -- and 22% of you don't.

Don't think you can afford to contribute enough to get the full match? You're probably wrong.

Each dollar you don't put into a company retirement plan is subject to federal, state and local income taxes. So if you're in a 30% combined (federal and state) tax bracket, each buck you toss into a 401(k) will reduce your paycheck by just 70 cents.

If you're afraid of going whole-hog, just inch your contribution up each quarter by 1% more of your salary. Most people can compensate for the decreased income by bringing lunch from home one or two more times each week.

3. Taking too little risk

Most 401(k) investors seem to understand that stock and stock mutual funds are going to give them the best returns in the long run. About 68% of 401(k) assets were invested in equities in 2006, according to the Employee Benefit Research Institute (EBRI), which surveyed 53,931 plans covering 20 million participants.

But about 15% of the participants EBRI tracked didn't invest anything in their available 401(k) stock choices.

It's understandable that some people would want to lighten up on stocks, either because they were approaching retirement or they learned they weren't quite as risk-tolerant as they thought. But few investors will be able to reach their retirement goals without any exposure to equities. Leading financial planners believe the average investor needs to keep at least half of his portfolio invested in stocks, regardless of age, if he wants an adequate income in retirement.

4. Taking too much risk

At the opposite end of the scale are the investors who overload on stocks. Nearly 40% put all or nearly all of their money into their 401(k) equity funds or into their company's stock, with little exposure to fixed-income investments.

During the go-go years, it was popular to opine that only old folks needed bonds. The stock market swoon, however, proved that most investors can benefit from the cushioning effect of bonds and cash. Many of the folks who panicked and cashed out at the bottom of the market might have been able to stand pat had they had some bonds adding value to their portfolios.

The classic balanced portfolio -- 60% stocks, 30% bonds and 10% cash -- is a good starting point for most investors. You can ratchet up the stock exposure if you're young or aggressive.

The risks of putting too much into company stock are so great that I'll give them their own section, otherwise known as:

5. Drinking the company Kool-Aid

In 1999, before Enron flamed out and took many of its workers' retirement dreams along with it, company stock made up 19% of 401(k) assets nationwide. According to EBRI, that percentage has since shrunk to 11%.

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