3 Mistakes to Avoid With Your 401(k)

Older and low-paid employees make the most errors with retirement accounts.

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The folks who need retirement savings the most—older and lower-paid employees—are the same people not benefiting as much as they should from 401(k)'s. That's the bad news, according to a new study by Financial Engines, a Palo Alto, Calif., firm that provides investment advice and portfolio management.

The analysis of more than 960,000 participants in a range of 401(k) plans found that 69 percent had portfolios with inappropriate risk or diversification, 36 percent held too much company stock, and 33 percent failed to contribute enough to receive the full company match.

Here are the major 401(k) mistakes, according to the report, and how to fix them.

Mistake No. 1: too much company stock. Forty-three percent of those over age 60 had more than a fifth of their 401(k) portfolios in company stock, compared with only 28 percent of those under age 30, the report found. And a quarter of participants who are 60 and older had half or more of their portfolio invested in their own company.

Aside from the risk of concentrating your savings in the shares of one company, having too much company stock can also hurt returns. Portfolios with more than a fifth in company stock can expect to accumulate an average of 18 percent less retirement wealth after 20 years, the authors calculated, compared with those holding less than 10 percent in company stock (given the same starting balance and assuming no future contributions).

"Despite recent company collapses and market volatility, many Americans still discount or underestimate the high risk levels associated with holding high concentrations of company stock," says Jeff Maggioncalda, president and CEO of Financial Engines. "Unfortunately, the older employees holding the highest amounts of company stock have the least amount of time to recover if their company's stock happens to take a hit.... Holding large amounts of company stock is actually a drag on the long-term growth of their portfolios."

Avoid the fate of Bear Stearns and Enron employees: Diversify your retirement funds beyond the company you work for.

Mistake No. 2: inappropriate risk. Participants earning the lowest salaries are the most likely to make investing mistakes, the report found. More than half of participants with annual salaries below $25,000 had portfolios with inappropriate risk or diversification, compared with only a third of those earning more than $100,000 per year, the Financial Engines study found. Younger workers often have too much money in bonds, and older workers bet too heavily on stocks. Undiversified portfolios with inappropriate risk may have 22 percent less projected retirement wealth after 20 years, compared with those in which assets are allocated more prudently, the authors calculated.

You can consult a financial adviser to find an asset allocation that's right for your stage of life. And mutual fund companies often give examples of model portfolios in their literature.

Mistake No. 3: not contributing. A quarter of the 401(k) participants surveyed were saving 10 percent or more of their salary. But despite the endless stream of financial news and advice about the importance of 401(k) savings, a third of active participants failed to save enough to get the full company match. Sixty percent did get the full employer match but are saving below the limits allowed by the IRS or the plan. And only 7 percent of active 401(k) participants came within at least $500 of the IRS or plan maximum allowed, thus getting the full tax break. (The most common employer match is 50 cents per dollar of an employee's contribution, up to 6 percent of pay.)

The good news? This is perhaps the easiest mistake to correct. For example, if a participant saves 1.9 percent of his salary (not enough to receive the full employer match), has a median account balance of $5,872, and continues contributing at the same rate to receive the partial employer match, he is projected to have a 401(k) balance of $46,800 after 20 years. But if he increased the contribution to 6 percent of salary (enough to receive the full typical employer match), the authors calculated, he would amass some $120,900 after 20 years. That's a difference of 158 percent. So, saving really will pay off.