401k plans are a great thing. Since their birth in 1980, these tax-deferred investment plans have empowered millions of ordinary Americans to take control of their finances and build robust nest eggs for retirement.
But access to the stock market and all its wealth and wonder is not without pitfalls, as the beating many of us took in the 2008-09 banking meltdown proved. Many folks with 401k plans got sucked into common mistakes that actually put their finances in worse shape and threatened their retirement prospects.
We can sum up many of those mistakes in terms of the classic seven deadly sins. They're serious offenses, and committing just one of these mistakes too often can condemn you to a subpar retirement. But thankfully, there are ways to find absolution and fix things before it's too late.
Deadly sin No. 1: Wrath
We all get angry at little things from time to time, so it's natural to get fired up either with yourself or with your fund manager when something goes awry with your hard-earned retirement account. But if you let that anger consume you, it can cloud your investing judgment.Let's say you joined a company in 2000 and dumped your 401k contributions into a number of Fidelity funds -- for instance, Fidelity Magellan (FMAGX), Fidelity Diversified International (FDIVX) and Fidelity Small Cap Growth (FCPGX). At the market's bottom in March 2009, you flew off the handle and bailed out. Over that period, Magellan had plunged by 75%, Diversified International had tacked on a measly 9%, and Small Cap Growth had fallen 35%.
Meanwhile, bailing out would have come at a significant cost. The obvious loss would have come from missing out on stocks' rebound by going to bonds or cash. Since March 9, 2009, Magellan has gained about 90%, Diversified International about 75% and Small Cap Growth more than 100%. On top of that, if you had cashed out your 401k, you'd have to pay income taxes and penalties on the early withdrawal that could eat up a quarter to nearly half of your money.
Obviously, wrath gets you nowhere and leads to bad decisions. Take a deep breath and think rationally before pulling the trigger.
Deadly sin No. 2: Greed
In this era of day trading and fast-paced Wall Street transactions, it's easy to make the mistake of thinking your 401k is a brokerage account. But that simply isn't true. Mutual funds are not designed for short-term trading to chase the flavor of the month but rather a long-term strategy that takes macro trends into account.The fact is that you're buying a mutual fund because you believe in the manager and the philosophy of the fund. If you think you're a better money manager, that's fine, but strike out on your own with a brokerage account. And realize that your pursuit of bigger profits in the next hot stock comes with a high price tag: taxes paid on the front end for any cash from your paycheck you put into the market and taxes on the back end on any profitable sale you make. And let's not forget that your employer isn't going to match your monthly contribution to a personal E-Trade account.
The bottom line is that even if you manage to make better decisions than your 401k fund managers, you'll really have to knock it out of the park consistently to offset the tax burden. Don't get greedy or hyperactive with your 401k. Make informed long-term decisions, and don't micromanage your portfolio.
