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Motley Fool: Avoid These 3 Critical 401(k) Mistakes

Motley Fool: Avoid These 3 Critical 401(k) Mistakes

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By    |   Friday, 23 September 2016 01:23 PM

 

There are three tips of sage advice regarding 401(k)s: contribute money regularly, invest it well and leave it alone. Conversely, there are also 3 major mistakes to avoid, despite the temptation, Motley Fool recently reported.

1] Increase that low “starter” default contribution

According to a survey by the American Benefits Council, the default contribution rate for more than half of respondents was less than 4% of their salary. If your salary is $50,000, that's only $2,000 per year you're setting aside for retirement. Over 30 years, assuming your salary goes up about 2% per year and you net an 8% average annual rate of return, you'd have saved about $298,000, the Fool reported.


"That may sound a like a lot, but it would only provide about $993 per month in retirement income. Even if your employer matches 50% of your contributions, your expected retirement income from your 401(k) would only be about $1,487 per month after 30 years.
“Here's where even seemingly small amounts can make a huge difference over long periods of time. If you bumped up your contribution to 6% of your pay, your monthly income in retirement would increase almost $500 per month to $1,980 per month. At the same time, your pay today would only go down about $83 per month,” the Fool reported.


2] Don't borrow from your nest egg
 

More than one-fourth of 401(k) participants who are eligible have an outstanding loan, according to Aon Hewitt. “When you borrow, you're missing out on the growth potential of your money. 401(k) loans generally charge relatively low interest rates -- the prime rate plus 1 percentage point seems to be most common. Meanwhile, money invested in an S&P 500 index fund has historically returned close to 10% per year. The interest you'll pay yourself is unlikely to match the returns you'd get by simply leaving the money invested.
Additionally, if you become unable to repay the loan, it will be treated as a withdrawal and subject to income tax, as well as a 10% penalty if you're under 59-1/2 years old. This can also be the case if you leave your job -- many plans require immediate repayment if you quit,” the Fool reported.


3] Avoid “leakage” when you use your 401(k) as emergency fund
 

“Leakage” happens whenever someone takes money out of their retirement savings accounts to help pay for present-day expenses. This can occur through in-service withdrawals or by simply cashing out your 401(k) when you switch jobs.

"Researchers at Boston College's Center for Retirement Research have attempted to show how damaging such leakage can be. The results show that in a typical year, about 1.5% of all IRAs and 401(k)s suffer some type of leakage. When they tried to show what that means for the average American, it came out to a nest egg that was $94,000 smaller than it would have been without any leakage," the Fool reported.
 

Meanwhile, conventional investment advice says to gradually shift money from stocks to less risky bonds as retirement age approaches.

Not so fast, says Eric D. Nelson, an investment adviser and founder of Servo Wealth Management.

“For an individual or family who is about to retire or is already in retirement and who needs a rising income stream over several decades, putting most of your money in a diversified portfolio of stocks represents your best chance for success,” he writes in a Seeking Alpha blog that compares the “lost decade” for the S&P 500, whose value fell from 2000 to 2009, with diversified asset allocations.

The key to growing a retirement portfolio is to look beyond the biggest U.S.-listed companies that make up the S&P 500, he says. Stock holdings need to be diversified to include smaller-cap companies and foreign equities.

“The decision of not only how much you allocate to stocks but also what stocks you own has never been more important,” he says. “Start with a portfolio that emphasizes equities, diversify them broadly, stick with your plan and you just might avoid seeing a lost decade destroy your retirement.”

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There are three tips of sage advice regarding 401(k)s: contribute money regularly, invest it well and leave it alone. Conversely, there are also 3 major mistakes to avoid, despite the temptation, Motley Fool recently reported.
401k, retirement, mistakes, savings
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2016-23-23
Friday, 23 September 2016 01:23 PM
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