There are many things you can do to optimize your 401(k), other retirement accounts, and overall retirement strategy. Then there are a few things you just shouldn't do.
Here are five ways to sabotage your own retirement nest egg:
1. Not saving enough.
No amount of good investing can make up for a total lack of saving. There are two components in the not enough money self-sabotaging routine.
Not saving early enough is the first no-no. Don’t squander your paycheck during your 20s and early 30s rather than investing in your retirement. During the first 15-to-20 years of your career, you may not be able to make large contributions. But your mantra during this time should be every little bit counts. Small contributions made early can still grow significantly through compounding.
Contributing too little is the second slip-up. Make every effort to maximize your contributions at any given time. So you could only contribute a little when you were younger? That doesn't mean you can continue that low rate as you progress in your career. You have to keep increasing your contribution rate. Don’t get carried away by taking on additional expenses each time you get a pay raise. You’re responsible for your retirement savings, so act responsibly!
2. Taking early withdrawals or loans.
This is a really quick and easy way to deplete your retirement savings. Early withdrawals face taxes and, possibly, an IRS penalty. Loans subject you to extra taxes. (When you take a 401(k) loan, you must repay yourself with interest. But, while your initial contributions could have been made pre-tax, your repayments must be made from after-tax money. Despite that, you will still pay taxes on that money and its gains when you take retirement distributions.)
On top of that, every moment your money isn't invested is a moment you’re not able to take advantage of compound growth. Remember how every little bit counts? If you take a loan or withdrawal now, you’re simply stealing from the 65-year-old you.
3. Blindly using your employer’s default investing option.
When you begin contributing to an employer-sponsored retirement account, you may not be required to choose your own investment lineup. In these cases, your contributions will be placed in a default investment. Some default investments are good while others may likely leave you short of your retirement goals, but you won’t know unless you do a bit of research. If you’re going to use the default investment make sure it fits within your risk tolerance and investment strategy.
4) Not rebalancing.
If you've taken action to create a retirement investing strategy, you've worked hard (hopefully) to choose a good portfolio lineup. You've established your risk tolerance, created a timeline to retirement, selected an appropriate asset class allocation, and chosen the optimal funds to fit in your asset class allocation. Don’t let all that go to waste!
Over time, gains in some sectors and losses in others mean your allocation percentages become skewed. You have too much money in the areas that have been the hottest and too little money in the cooler asset classes. That means you no longer have a portfolio tailored to your risk tolerance and retirement timeline. You may have too much risk, or you may be sitting in an overly conservative position. Rebalancing fixes the problem instantaneously.
Additionally, rebalancing causes you to follow the age-old investing axiom of “buy low, sell high.” As you rebalance, you sell a portion of your portfolio that’s been hot (selling high) in order to buy from an asset class that’s been slower (buying low). Over time, in combination with dollar-cost averaging, this strategy can help provide a track record of effectiveness.
Trading often is risky by definition because it requires that you attempt to time the market. In the case of your retirement savings, the risks are too high. This is your one and only chance to save and invest for retirement. You don’t get a redo. You can’t get retirement scholarships or loans. You can’t rent your retirement for a little while so you can replenish your savings. Nope. You have to protect your retirement savings with a wise investing strategy. Rather than trading a lot, use dollar-cost averaging and rebalancing in a thoughtfully allocated, diverse investing lineup. And, incidentally, fees can eat your gains pretty quickly if you treat your retirement account like a day-trading account.
Don’t sabotage your efforts to save for retirement. This list is easy to avoid with planning and patience.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.