By Paul S. McNulty, CFP®
I would bet that many of us claim to live fairly risk-free lives. After all, we don’t race cars, skydive, or run with the bulls. However, whether we are aware or not, we all take risks every day. (I’m not just talking about texting while driving—but please don’t do that!)
I’m talking about your 401(k). I’m sure you’ve heard about how important and necessary a 401(k) plan is for retirement, but have you considered the risk associated with it? Although it’s a beneficial investment opportunity, inherent risks come with it, such as choosing appropriate funds or understanding hidden fees. Let’s be honest, when was the last time you analyzed your 401(k)—or even logged into your account? Do you know how much risk is in your 401(k)?
Why Is A 401(k) Unique?
Your 401(k) differs from other accounts in a few ways, and plays a specialized role in your financial planning. First, you likely receive your 401(k) from an employer who may match contributions, giving you more incentive to contribute a larger percentage of your income. Furthermore, you also have the ability to choose how and where your money is invested, and your contributions are made on an after-tax basis. At the maximum, you and your employer can contribute jointly up to $56,000 (for 2019) or $62,000 for those aged 50 or older.
However, a 401(k) does require maintenance. Your company provides a way for you to save for retirement, which is great, but their job does not typically include vital aspects such as helping you manage the risk in your account, providing professional investment advice, or giving insight into fees you may not be aware of.
So what can you do to ensure your 401(k) is working hard for your financial future and isn’t carrying too much risk?
Can You Avoid 401(k) Risks?
The more you know about something, the more you can prepare for it. Let’s look at a few risks 401(k)s are susceptible to and ways you can seek to avoid them.
401(k) values typically rise and fall with the stock market, meaning they don’t offer protection from losses. If the stock market does well, so may your 401(k). But if it drops, so can your retirement account, no matter how soon you need the money. The key to helping mitigate this risk is to maintain the proper asset allocation for your risk tolerance level. Examine the investment options offered by your company and choose the ones at your risk level, being sure to diversify your choices accordingly.
Most companies enroll their employees at a 3% contribution rate, but 3% will not get you to your retirement goals. Likewise, many plans choose allocations for you, but are those really the best choices for your situation? Because of the many decisions that come with starting and managing your 401(k) account, many people employ a “set it and forget it” method, neglecting to review its progress and regularly rebalance. In fact, 25% of workers with a 401(k) have never made adjustments to their account. (1) In a matter of a few years, those who neglect their 401(k) may realize that their account no longer reflects their risk tolerance, time horizon, and needs. Take the time to create a 401(k) strategy, check in with your account to rebalance, and increase your contribution rate as your financial situation allows.
Relying On Company Stock
If you have the option to purchase employer stock, be sure to exercise caution. This is important because if your company performs poorly, it will depress the stock price and could lead to layoffs as well. Depending on how much company stock you own, there goes a portion of your portfolio, your income, and your health insurance all at once. Sadly, many people have experienced this. Back in 1999 when Enron filed for bankruptcy, more than $1 billion in employee retirement savings simply evaporated. Many Lehman Brothers employees experienced the same thing as well. (2)
According to a survey commissioned by retirement investment advisory firm Rebalance IRA, nearly half of investors don’t think they pay any fees in their retirement accounts, and 19% believe their fees are less than 0.5%. But the reality is, you are likely paying closer to 2% or 3%. Depending on the account and company, mutual fund fees can be staggering and consume a large chunk of your gains. On top of that, there are many undisclosed costs (such as transaction fees, bookkeeping fees, finder’s fees, etc.) that eat away further at your retirement dollars. By choosing investments with lower fees, you may be able to pursue higher returns.
Lack Of Investment Guidance
The average 401(k) plan offers 25 investment choices. While options are good, sometimes too many can confuse and overwhelm investors. Without sufficient investment knowledge, employees may choose a little of each and end up with a portfolio that isn’t diversified or appropriately aligned with individual needs.
Get Your 401(k) On Track
Now that you’re aware of these common and potential risks, how confident are you that your 401(k) is optimally set to help you pursue your retirement goals? You work hard to save for retirement; don’t be passive about preserving it. If you’re feeling uncertain, my recommended first step is to meet with a financial professional to review your strategies.
We at Boston Metro Advisor are ready to help you create a retirement strategy that gives you a clear view of what you need to do to safeguard your 401(k), seek to avoid unnecessary risks, and work towards your goals. We’ll help you understand how your employee retirement plan works, how to optimize your benefits, and coordinate your plans with your other retirement and investment strategies. Contact us for a complimentary consultation by calling (781) 995-0253 or email me directly at [email protected] today!
Paul McNulty is the founder of Boston Metro Advisor with over 20 years of experience helping people navigate the ups and downs of the economy toward the financial future they envision. His education consists of a Bachelor of Science in business administration from the University of Rhode Island and the CERTIFIED FINANCIAL PLANNER™ (CFP®) professional designation.
Paul’s experience and education have made him a multi-faceted professional capable of assisting people with virtually all their financial needs. His services include every facet of retirement planning, from 401(k) rollover services and income planning to wealth management and estate planning. Paul has been active in his community over the years as a youth sports coach. When he’s not spending time with his wife, Cindy, and their two children, who are both recent college graduates, Paul enjoys reading, playing golf, and fishing. Learn more about Paul by connecting with him on LinkedIn.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All investing involves risk including loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.