7 Biggest 401(k) Mistakes To Avoid

A 401(k) is a good way for families to save money.

Many people start investing with their company's 401(k) plan because it’s easy and sometimes the company adds money to your account too.

This is easier than opening a different account and picking investments by yourself.

But just putting money into a 401(k) for many years doesn’t mean you’ll have enough for a comfy retirement.

Surprisingly, most people only have a little over $88,000 in their 401(k), which isn’t enough.

The AARP says you might need about $1.5 million to retire comfortably.

So, why aren’t people saving more for their retirement?

There’s more to getting ready for retirement than just signing up for a 401(k).

Many people don’t know the best ways to save and invest for their future.

Now before we start, this is Ivan here from the Vanilla Investor, a former investment analyst and with over $100k invested in the markets.

My goal is to bring you simple finance at your fingertips.

Today, we will be covering 7 common mistakes people make with their 401(k):

Not using your company match.
Holding too much of your company’s stock
Not increasing your contributions over time
Cashing out when you change jobs
Ignoring the drawbacks of a 401(k)
Not tracking how your investments are performing
Cashing out your 401(k) for a big purchase

So without further ado, let’s dive right in!

1: Not Contributing Up To Your Company’s Matching Contributions

Mistake number one: not putting in as much money as your company offers to match.

One of the best parts of a 401(k) plan is the employer match.

This is like extra money your company adds to your retirement account when you put in some of your own money.

For example, if your company matches up to 5% of your salary, you should try to put in at least 5% to get the full match.

If you don’t, you’re missing out on free money!

This matching can really help grow your retirement savings.

But there’s a catch called "vesting."

This means you might not fully own the company's contributions right away.

For example, you might own:

0% of the company's match in your first year,
50% after two years,
75% after three years,
and 100% after four years.

If you leave the job after one year, you won’t get to keep the company's matched money.

So, if you’re thinking about changing jobs, check your vesting schedule.

Sometimes, it might be worth staying a bit longer to get the full value of the matched contributions.

2: Buying Too Much Company Stock

Mistake number two: buying too much company stock.

Sometimes, you can buy your company's stock at a lower price, which might seem like a great deal.

But it's risky to depend too much on one company's stock.

Experts recommend most investors keep their money in broad investments like index funds or ETFs and only have about 20% of their savings in individual stocks.

You can spread this 20% across one or a few different stocks.

But it's important not to invest too much in just one stock.

Putting all your money in one place is risky.

Many employees trust their company and invest a lot in its stock.

Unfortunately, if the company has problems or goes out of business, you might lose your job and a lot of your retirement money.

To keep your money safe, spread your investments out and don’t count too much on one company's stock.

3: Not Increasing Your Contributions

Mistake number three: not increasing how much you save in your 401(k) as you earn more.

Usually, the amount you put in your 401(k) is a part of your salary.

So, if you save 5% of what you earn in your 401(k), that amount goes up if you get a raise.

But if you want to save more and maybe stop working sooner, you should try to add more over time.

For example, if you make $40,000 each year and save 5%, you're putting $2,000 into your 401(k) every year.

If you get a 5% raise, your salary goes up to $42,000, and your 5% savings goes up to $2,100.

Although you're making $2,000 more, your 401(k) savings only go up by $100.

Since the money you use to live doesn't go up as soon as you get a raise, you could start putting 10% of your yearly salary into your 401(k), which would be $4,200.

Even if you feel like spending your raise right now, adding more money to your 401(k) will help you a lot in the future.

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4: Withdrawing Money When You Change Jobs

With that said, mistake number four is taking money out of your 401(k) when you change jobs.

If you get a new job, don’t take out your 401(k) money.

This could mean a 10% early penalty fee, especially if you're under 59 and a half years old, plus you'll owe a lot in taxes.

Sometimes, you can leave your money in your old job’s 401(k) plan, but not always.

If you have to move your money, think about putting it in an IRA or in your new job's 401(k) plan if they have one.

A direct rollover puts the money right into the new account, so you won’t spend it by mistake.

5: Not Paying Attention To The Drawbacks

Mistake number five: Not knowing the limits of a 401(k).

While 401(k) plans are helpful, they have their downsides, and it’s important to know them and look at other choices.

One big problem is the small range of investments you can pick from, usually only a dozen or so.

These choices might be okay, but the fees can be higher than an IRA, or an Individual Retirement Account.

With an IRA, you can choose from a lot more investments, which might cost less.

Even a small fee of one or two percent can really lower how much you save by the time you retire.

Also, IRAs let you invest in single stocks if that’s what you want.

Another thing to think about is taxes.

Putting money in a Roth IRA can be good because you don’t pay taxes on it when you take it out in retirement, unlike with a 401(k) where you do.

Deciding if it’s better to pay taxes now or later depends on how much money you think you’ll make in retirement.

If you think you’ll be in a higher tax bracket then, relying only on a 401(k) could mean a big tax bill.

6: Ignoring How Your Investments Are Doing

Mistake number six: Not paying attention to how your investments are doing.

When you first chose how to invest your money in your 401(k), you picked different risk levels.

But if you haven’t checked on those investments since then, it's important to start now.

It’s crucial to keep track of how your investments are doing compared to the overall market.

Every year counts because your savings can grow a lot through compound interest.

For example, if your investments average a 10% return over your career, you’ll have more money at retirement than if they average only 6%.

The overall market usually averages about 10% each year, so that’s a good goal to aim for.

But remember, returns can change depending on how the market is doing.

To check if your returns are good, compare your funds to similar ones.

If you have a small-cap fund, you could compare it to the S&P SmallCap 600 index.

If you have a target-date fund, compare it to a similar one from a company like Vanguard.

If your fund isn’t doing well, there’s no need to keep your money there.

If you have many years before you retire, you can take more risks with your investments.

If you find that your 401(k) doesn’t have good options, think about putting extra money into an IRA or a regular brokerage account after you get all the money your employer will match.

7: Cashing Out For Big Purchases

Mistake number seven: Taking money out of your 401(k) for big purchases.

It's one of the worst financial choices you can make.

Using your 401(k) money to buy something expensive like a new car or fancy item might seem easier than finding other ways to pay for it, but it can hurt your money in the long run.

If you withdraw money before you're old enough to retire, you'll have to pay big penalties and taxes.

The biggest problem is losing the chance for your money to grow over time.

When you keep your money in your 401(k), it can grow a lot, like a snowball getting bigger as it rolls down a hill.

Taking out money early stops this growth, so you'll have less for the future.

Only take money out as a last choice, after you've tried everything else.

To avoid needing to use your 401(k) money, try to save enough in an emergency fund to pay for three to six months of living costs.

This can help handle unexpected expenses without hurting your retirement savings.

Investing in a 401(k) is easy for everyone, and starting one is a good beginning.

If you understand a bit about it, your money can grow over time.

But if you want more options than just a 401(k), think about a Roth IRA.

Many people talk about how good a Roth IRA is with a 401(k).

Read this article to learn how you can save enough with a Roth IRA and be a tax-free millionaire by investing $12 every day.

Thank you for reading, cheers!

- Ivan