In this day and age of DIY tutorials and life-hacks, you might be tempted to do your 401k all by yourself. But be wary, brave traveler! There are several pitfalls you could get into if you follow this path.
Pitfall #1: Being Too Conservative
The old rule of thumb was that if you subtract your age from 100, then that should be the percentage of stocks in your portfolio. For example, if you were 20, then 80% of your portfolio would be in stocks, and 20% in bonds.
With Americans living longer, and empirical evidence of higher long-term returns from stocks vs. bonds, this framework is a bit outdated. Instead, raise that number to 110, or even 120. So, your portfolio would have 90-100% of stocks.
Pitfall #2: Being Too Aggressive
We know, we know. You literally just read not to play it too safely. But here’s why you shouldn’t be too reckless with your investments. Say you’re less than 5 years away from retirement. We recommend that around 40% of your 401k get invested in bonds, with the other 60% in stocks.
As folks start getting closer to retirement, their nest egg needs to be safer from a market crash or a decline in stock prices. That’s why blooom continually monitors and periodically rebalances our clients’ accounts as they get closer to retirement, bringing down the percentage of stocks and increasing bonds.
Pitfall #3: Forgetting to Rebalance
What is rebalancing? It’s basically double-checking to make sure your money is in the right place and the right amount. But beyond that, it’s also a way of making sure that your investments stay in line with your long-term goals. Most people think they can do this on their own, but it can take a fair amount of time and consistency, especially if you don’t know which funds to pick.
Based on a survey of over 5,500 blooom clients1, 59% said that they do not rebalance their accounts several times a year. Another 21% said they “don’t know” whether they rebalance often.
If you want to know HOW an account is rebalanced, Nerdwallet has 5 Steps to show you.
Pitfall #4: Investing in Cash
If you want to invest and make your money work for you, then you have to accept some risk to get a return over the long haul. Merely saving up cash won’t get you there. For investors who have only a few years until retirement, holding part of your portfolio in cash can be a great way to meet short-term expenses, but it’s a terrible way to build long-term wealth.
Why? It’s because of the almost non-existent returns on cash over the past decade. Also, if you just hoard up all of your cash, your purchasing power will go down over time due to inflation.
Here’s a crude example: say you saved $5 now with the hope of buying a latte on Day 1 of your retirement. But unbeknownst to you, natural economic inflation would then lead to prices rising to $10 a cup.
Pitfall #5: Getting Off Target
Target-date funds, at first glance, seem to have everything you want in an investment: a diversified allocation that gets more conservative as you get closer to retirement – your target date.
But they’re often misunderstood and misused, i.e. you’re generally supposed to select one and forget it. In analysis of our data, more than 37%2 of people had selected more than one target date fund.
Another pitfall of target-date funds? You might pay ridiculous fees, which end up lining Wall Street’s pockets.
Pitfall #6: Racking Up Hidden Fees
Of the more than 5,500 people who took our survey1, only 18% said that they minimized hidden investment fees in their 401ks. The remaining 82% said either “no” or they “didn’t know.”
Unsurprisingly, most Americans don’t know much about hidden fees either. According to Inc., 92% of Americans don’t know what they’re paying in fees.
And they cost you. Forbes detailed an example where a 0.93% difference in hidden fees between two funds can cost up to $215,000 for a single investor. Why can such a small number have such a big cost? Compound interest – or as Albert Einstein is said to have called it, “the world’s most powerful force.”
At the end of the day…
With the 6 pitfalls it might not seem as easy to go it on your own. For blooom clients, they have a guide actively help down the trail to retirement.
1Based on a quiz taken by 5,668 blooom clients from June 23, 2017 to August 29, 2017.
2Based on blooom client data as of August 28, 2017.