401k misconceptions

Over more than 30 years as a 401k plan consultant, I have worked with some of the most prestigious companies in the world including Apple, AT&T, IBM, John Deere, Northern Trust and Northwestern Mutual. And, I am always surprised by the simple — but significant — 401k misconceptions many people have about their plans.

Here are the most common 401k misconceptions I run across.

1. I only need to contribute up to the maximum company match

Out of all the 401k misconceptions I hear employees talk about, this is the most frequent. Many plan participants believe their employer is sending them a message on how much to contribute. As a result, they only contribute up to the maximum matched contribution percentage.

In most plans that works out to be only 6% in employee contributions. However, many studies indicate that participants need to add at least 15% each year to their 401k accounts.

2. It is OK to take a participant loan

I have had many participants tell me, “If this were a bad thing why would the company let me do it?” This is one of the most prevalent 401k misconceptions.

Account leakage via defaulted loans is one of the reasons some of us are not able to save enough for retirement. Many people, when they change jobs, elect to default on outstanding 401k plan loans because they don’t have the cash lying around to pay the loans back.

In addition, taking a 401k loan is a horrible investment strategy. Generally, if you can take a loan from somewhere else, you should do it.

3. Rolling a 401k account into an IRA is a good idea

There are many investment advisors working hard to convince everyone this is a good thing to do.

However, higher fees, lack of free investment advice, use of higher-cost investment options, lack of availability of stable value and guaranteed fund investment options, and many other factors make this a bad idea for most of us.

The Department of Labor agrees, as shown in its recent auto portability proposal.

If you can, roll your prior 401k account balances, and your IRA accounts, into your existing employer’s 401k plan. It is a much more cost-effective option.

4. My 401k account is a good way to save for college, a first home, etc.

When 401k plans were first rolled out to employees decades ago, human resources staff helped persuade skeptical employees to contribute by saying the plans could be used for saving for many different things. Creating many 401k misconceptions. They shouldn’t be.

It is a bad idea to use a 401k plan to save for an initial down payment on a home or to finance a home purchase. Similarly, a 401k plan is not the best place to save for a child’s education — 529 plans work much better.

In addition, your 401k plan is not the best place to save for a new car, boat or that deluxe vacation. If you wish to enjoy any sort of quality of life in retirement, use your 401k retirement plan to save only for retirement.

5. I should stop making 401k contributions when the stock market crashes

I have had many participants say to me, “Bob, why should I invest my money in the stock market when it is going down. I’m just going to lose money!” When the market is falling or has decreased significantly in value, stocks are on sale. It is the best time to be investing in the market!

Stick with your contribution plan in all types of markets. Stopping and starting contributions is not a good way to accumulate the balance you are going to need to retire.

The biggest challenge participants who stop contributing face is when to resume their contributions. Most wait until the stock market recovers. As a result, they end up buying when the cost of stocks is high — not a good investment strategy.

6. Actively trading my 401k account will help me maximize my account balance

Studies have consistently demonstrated that trying to time the market (this includes following newsletters or a trader’s advice) is rarely a winning strategy. Consistently adhering to an asset allocation strategy that is appropriate to your age and ability to bear risk is the best approach.

No one can predict what the market will do in the future. Please don’t believe that you or anyone else can. Don’t try to “trade” your account. Everyone I have known who did this traded their account down to nothing.

7. Indexing is always superior to active management

Although index investing ensures a low-cost portfolio, it doesn’t guarantee superior performance or proper diversification. Access to commodity, real estate and international funds is often sacrificed by many pure indexing strategies. A blend of active and passive investments often proves to be the best investment strategy for most of us.

8. Target date funds are not good investments

Most experts who say that target date funds are not good investments are not comparing them to most participants’ allocations prior to investing in target date funds. One of the biggest 401k misconceptions is that participants aren’t improving their investment approach when they allocate their balance to target date funds. Most do.

Target date funds offer proper age-based diversification. Many of us, before investing in target date funds, may have invested in only one fund or a few funds that were inappropriate risk-wise for our age. Studies show that the average number of funds used by 401k participants is between three and four. That generally is not enough to ensure proper diversification.

9. Money market funds are good investments

These funds have been guaranteed money losers for a number of years because they have not kept pace with inflation.

Unless you are five years or less away from retirement or have difficulty taking on even a small amount of risk, these funds are below-average investments. Try to invest in stable value or guaranteed fund investment options instead.

10. I can contribute less because I will make my investments work harder

Many participants have said to me, “Bob, I don’t have to contribute as much as others because I am going to make my investments do more of the work.” Most participants feel that the majority of their final account balance will come from earnings in their 401k account.

However, studies show that the major determinant of how much participants end up with at retirement is how much they contribute rather than how much they earn.

11. One of the biggest 401k misconceptions: A million-dollar 401k balance is enough

It should be enough, but for many of us, it won’t be.

A lot of us hope to do things in retirement that we only dream about during our working years. Others will experience unexpected health care costs that can quickly deplete their savings. Quite a few of us will live much longer than we ever thought. As a result, many experts feel that a million-dollar 401k plan balance won’t be enough.

I hope these suggestions help you become a better 401k plan investor and help you overcome your 401k misconceptions.


About the Author

Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs, and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly $475 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.