One Airport Place,
There are many mistakes that people make with their 401K accounts. Today we try to help you avoid those mistakes now instead of trying to fix them later. They mainly fall into three categories.
Contribution Level Mistakes
Welcome back to Financial Matters with Rich Oring. I am John Jag A, joined once again by Richard Oring from New Century Financial Group. Great to be back with you, sir.
Hey, Jack, nice to hear from you again.
I think you knew that I was a big sports fan when you told me what we're going to talk about today, and that is playing fifth quarter quarterback with your 401k. I love the analogy. Let's dive right in. What do you mean by playing fifth quarter quarterback?
Okay. Actually, I didn't choose this title because of you, Jag.
Okay. We could've just pretended. You could've rolled with it, but that's fine.
I know, I know. I didn't want to make you feel special, then you were going to expect more often. Really, I chose this podcast because when I do enroll in meetings for 401k in place, I always use this quote, "You don't want to play a fifth quarter quarterback on your 401k." It's very easy to look at past performance and say, "This is what I'm going to do to make my decisions, based on the facts." We see people, after Monday night football, come into work and they're like, "Oh man, if I was a coach, I would have done this and this and this. And I would have won the game." Unfortunately, it doesn't work the same way. It doesn't work in professional sports and it surely doesn't work in your 401k.
All right. So, we're going to talk about three specific categories here, when it comes to 401k mistakes, which of the first is mistakes that are made in contribution levels for employee contributions. Next, we'll cover the investments. And then finally, some miscellaneous stuff. So again, let's start with the contribution levels. What are some common mistakes that people make here?
Sure. You start your job. You can't figure out how you're going to make ends meet, so how are you ever going to make contributions into your 401k? What people do is they push it aside. They push it aside because the bills are coming in every day. They're trying to figure out how to take out their girlfriend or boyfriend out on a date and how they're going to pay for everything. They got car payments and everything. So, you know what? This is not that important. This is 20 years, 30 years down the road. I'll worry about it in a few years.
Let me survive today so I can get to tomorrow.
Exactly. The way money works is, when you make investments, it compounds.
That interest. Yep.
So, the earlier you start, the reality is less you'll need. There's charts out there where it will show you if you start at age 21 putting so much way... to get to a million dollars, let's say... you only need XYZ. But if you wait 10 years, it's almost double that amount you would have to do to get to a million dollars.
People worry so much about surviving in the moment, they don't realize that if they can just set aside even a little bit right now, it quite literally pays dividends later.
Exactly. I hate when people say, "I can't afford to do it," because you really can't afford not to do it.
All right. People worry about putting off those contributions and sometimes they don't even put anything in, right?
That's correct. We have the new Secure Act and there's been some changes and incentives for employers to have auto enrollment now for employees. They've had it in the past. Not all employees put it in. So now, if you don't do anything, you don't even respond, they're going to auto enroll you in the 401k, but don't kid yourself. That's not going to be enough to get you to retirement. For those who don't know about the new Secure Act, I suggest that you go and Google it. There is some changes that our government made as of January 1st of 2020.
Important to mention while on the topic of the Secure Act, this thing passed the week before Christmas, in the middle of impeachment, and so much was going on in the news cycle and everybody's getting ready to travel and buying their holiday presents at the last minute, it kind of flew under the radar, but it actually took effect January 1st of this year. It's something to definitely get familiar with.
Exactly. Especially if you have a parent who's getting closer to retirement or close to 70 and a half. There's a lot of rules that changed.
All right. Richard, besides people not contributing to their retirement accounts, what are some other factors and other mistakes that come into play here?
I guess the other big one is I'm not putting enough in. Some people start off with 1% or 2% and they think that's enough. Sometimes they miss out on even capturing 100% of their employer match because they're not doing enough. We'll talk about that more later on the podcast, but they never increase it either. A lot of people put it on set and forget. They set it up, they do 2%. That's what I can afford. Then, they forget about it.
Consistently going back and readjusting your contributions, especially as you get raises. It's not proportionate. It's not like you make a thousand dollars more and you increase your contribution by 2%. It may not even be the full thousand dollars of the raise. You should increase your percentages every year. I always encourage people. It should hurt a little bit. You shouldn't notice it coming out of your check for the first month or two. Eventually, as you have deferrals, you kind of get used to it and you don't miss it. You adjust.
And if it's coming out of a raise, it's money that you hadn't included in your budget anyway. Theoretically, there's really no reason not to do it.
We talked about mistakes made on the contribution levels. Next, we want to cover investment mistakes. Where do you want to start here?
Okay. This is what I call the lunch room conversation. You get your enrollment book, or now it's online, and you print off all the investment choices. The most common thing I see people do is they go down the list of investments and they say, "All right, what did really, really well for the last 12 months?" Maybe three years rolling period they're looking at and they take a little pen and they check off one, but then they're like, "Oh, man, I've heard not to put all my eggs in one basket. That would be kind of silly. So, let me just pick the top four performing funds."
Well, if you had a category like large cap growth or international perform well over the last two years, they're probably picking two of those funds in the same category. So that doesn't make sense. They want to diversify their risk. They should understand what they're investing in. They shouldn't just be asking their coworkers what you invest in. They shouldn't be looking at past performance as an indicator for future performance. Those are very common mistakes I see in the investment side.
One of those things, too, where you might be asking your coworker about something, your coworker could be 20 years older or 20 years than you and in a completely different stage of planning for retirement and getting ready for it. So, what's right for them may not be right for you at all.
Exactly, and everyone's risk is different too. The other person might have an inheritance. They might be sitting on a half a million dollars you don't know about. So, they don't need to take as much risk to get to their goals. Maybe you don't have enough money you can save, so maybe you have to take more risk. We're going to talk a little bit about that later in the podcast too when we go over some objectives and stuff like that and goal planning.
Also, when you're talking to these coworkers of yours, unless you work for a certain type of company, these are not experts in the market. It's one thing to ask, "Hey, what kind of car should I get? Do you like your car?" But you're talking about your money and your future and you really need to talk to a professional when it comes to this, like yourself, Richard. What other mistakes do people make on this stage of things?
You said talk to a professional and we'll talk about that, again, later in the podcast, but this is something everyone can do on their own, especially in the beginning. They don't always need a professional if they're good at doing some research and understanding. There are some guides that help the employees choose some of the investments. Sometimes they have models you can choose from. But the one thing you want to do is understand what you're choosing, what you should be expecting.
If you're choosing something in equity, let's say a small cap equity, that's pretty aggressive. You should know what the upside is, because usually they're playing that fifth quarter quarterback in the lunchroom, looking at the past performance. They're like, "Wow, 20 some percent last year." But let's look at the down years. How much can it go down? Does it go down quickly in a short period of time? Does it go down in a year? How long does it take to recover? What kind of companies are in those categories?
Whenever they're buying something, they should understand, enrolling in that investment, they should understand what the expectation of that investment is to do, the good and the bad. You don't expect to buy a short term bond fund and get double-digit growth numbers, but you're also expecting not to lose money. A little research, you can Google and say, "What's my risk buying fixed income?" And maybe, because interest rates are really low right now, rising interest rates usually can effect a bond price to go down. It's a reverse correlation between the two interest rates and bond pricing.
Understanding that, taking the time just to Google that investment and see past performance, what it's done on down times and positive markets, and what effects it. Bond market's very easy. It's interest rates.
The other thing I noticed is when people work for public companies. A lot of times, they're offered a stock outside the 401k. They can purchase the stock once a quarter at 15% discount and then they'll hold it for three months. Or maybe they have stock options, incentive stock options for performance. Then, they overweight it even more by putting stuff in their 401k of the company stock. We've seen this before. We've seen people having an individual stock holding in their portfolio, which dramatically increases their risk. We've all heard don't put all your eggs in one basket. As good as your company might be, let's not forget Enron and WorldCom. Those people lost a lot of money. They never expected that to happen. They never expected those two humongous companies just to fail. So if you could imagine, if you were overweighted in those companies, your retirement was destroyed.
No, the idea is if you have stock options and you are invested in the company that you're in, that talks to the importance of diversification, because you want to be invested in other things, because if you're now compounding everything you have invested in that one company that you work for, your risk just multiplies exponentially.
Exactly. You know what the funny thing is? I know someone's listening to this right now and they're saying, "I worked for Microsoft for 20 years. This guy doesn't know what he's talking about. I made so much money." Again, looking back at it, you probably did a great job doing it. Financially, it's not the smart thing to do.
Another thing I see people do in their 401k, making mistakes, is, Oh my God, the market's dropping. I'm losing money. I got $10,000 in my 401k. I just lost a thousand dollars. I got 9,000 now. Holy crap, I can't afford to keep seeing my money drop, drop, drop. I'm getting out. Then, they just captured that loss and they're not going to be there when the market turns around.
What they really should be thinking to themselves is, "Great. The market's going down. I'm not retiring for another 20 years. I'm buying more shares of the same thing, which was doing well." It's all about the share. When the price is down, you're accumulating more shares and, when the price goes up, you have more shares times that share price. It's going to be worth more. It's like going to the department store and you want to buy a winter coat and you're like, "Crap, it's on sale. It can't be as good. I'm going to come back two weeks later and see if it's off sale. Maybe it got better by then."
I like that analogy.
It's the same thing. If you pick those investments, you did your research and you thought they were good investments at that time, just because the market drops doesn't mean your investments are bad. If you really were to peel back that investment and see what holdings they were, maybe it's Microsoft, maybe it's Home Depot, Best Buy. You just keep going on and looking at the underlying holdings. If all those companies kept on going down and down and down and down, we have bigger problems than just your 401k.
Exactly. The old cliche is buy low and sell high, but I think a lot of times the natural emotion of things is for people to freak out. If it gets too low, they want to sell. And if it gets too high, they want to react to the market and buy. But you think about the crash 11, 12 years ago in '08, '09. People panicked and got out, but the people who were able to ride it out, it eventually bounced back and they ended up making money on the deal, right?
Exactly. Another common mistake, kind of chiming on what you're saying, is rebalancing. Make it simple. You pick four investments. You pick the large cap growth, the large cap value, international, and a fixed income. I'm not telling anyone to go take that allocation. I'm just throwing four asset classes out there.
Just naturally, they're going to change from 25%. One's going to do better than the other one year. So by percentages, one might go to 30, one might go to 20. Looking at it maybe once a year or whenever you want to do it, is you rebalance back to the 25%.
What you're doing is exactly what you said earlier, is you're forcing yourself to sell at a high and buy something at a low. If you had the confidence when you allocated at 25% across the board, there's a very good chance one of those asset classes that didn't perform as well will perform well going forward. Just a matter of time.
You're doing just a little bit of maintenance. You're not changing your allocations, you're just tweaking a few things to keep it at the numbers that you've decided you wanted to be at.
Correct, and if you're a fortunate to work for one of those companies where you have company stock in there and it just takes off and you have additional shares outside, well this is a great opportunity to rebalance your 401k because if you sell that company stock within your 401k, there's no tax consequences. Whereas, if you do it on the outside accounts, non-qualified accounts we call them, there could be a tax consequence of doing that.
And that is a whole different ball of wax we can get into another time.
Last of the three categories you wanted to talk about today, Richard, are the miscellaneous mistakes. This is a pretty wide net we're casting here, but talk about some of these.
These topics in this category is I just really couldn't figure out where to place them, but I thought they were important enough to talk about in this podcast.
The first thing you want to do is create a budget. If you're married, I recommend sitting down and doing it together. We mentioned this in previous podcasts. If you're in a household, work together. You'll be more successful.
You got to do a budget and figure out what your real expenses are. There's always discretionary money you can cut back on. All right. So, that's the first thing is you got to treat yourself like a bill. We say you should pay yourself just like a bill. If you say, in your 401k, you know that you want to do 5% to start, take that off from your net pay and then figure out what your cashflow is for the remaining of the month to cover your expenses.
That's so important because I think so many people, when they make a budget, they kind of fall back on this, well, whatever's left at the end of the month is my walking around money. But if you have a set number to allocate to that, it helps you plan better and then, maybe if there's something leftover, you invest it, or you save it, or you pay a mortgage down earlier, or whatever it is. But having that set number to pay yourself... like you said, treating yourself as a bill... really pays off.
Yep, and this goes farther, even outside of the 401k. Once you get comfortable with doing that, I always recommend clients having additional savings outside what we call qualified accounts... IRAs and 401ks... and started building up a non-qualified account because the liquidity. When you need the money, you can take it. Again, I always tell people, "Hey, if I take $5 out of your wallet, would you notice? No. All right. So I know you could do $20 a month in savings. How much is it? $10? We get to a point where they would notice, but we start with that number and then usually, what I do with my own clients, let's say they're doing $50 a month, $100 dollars a month, we'll eventually increase it. I'll gradually say, "Hey, can we increase it another 20 bucks a month?"
One of my best success stories, when I first got into the business, I had a husband and wife and we started at $50 a month. They're up to $750 a month now.
The account value is over a hundred thousand dollars and it's awesome that they were able to be disciplined and do this. So, pretty much anyone can do it.
Got it. All right. What about Roth 401ks? This is a really complicated area for a lot of people.
Yeah, I find a lot of confusion with this with people. I go to someone in their thirties or early forties and I say, "Hey, does your company have a Roth 401k?" And they're like, "Uh, don't qualify for it any way, Rich. I make too much money." I go, "Well, no, no, that's a Roth IRA. A Roth 401k has no income limits." They're like, "Oh, I didn't know that."
Then we started talking about, based upon their current tax bracket and what we think our future tax bracket is going to be in the future, does it make sense to put some of their contribution in a Roth 401k or a traditional 401k? It all comes down to the tax analysis as of today, how long it'll grow for tax deferral in the future tax brackets.
So, everyone's individual case on this. I always recommend someone like that, if they're confused, always seek out a CPA, an accountant, a financial advisor, if they feel comfortable doing some tax planning on their own from the analysis. Paying a little bit more now in taxes could pay off in a big run later on.
It comes down to that individual situation where you just really need to make sure you talk to somebody who can confidently run the numbers and figure what the right move is for you.
Exactly. The employer contribution will always be traditional. The employer does a match or a profit sharing contribution. That is always a traditional contribution, so they take a tax deduction that year and they put it in your account. When you take it out, it's going to be taxed as ordinary income and just remember on a Roth contribution, an employee Roth, you're putting it in after tax dollars. When you take it out, it's tax-free.
And it grows tax free as well.
Yep. Maybe on a future podcast we'll talk about taking withdrawals out in retirement and how blending non-qualified and qualified distributions correctly could keep your tax bracket at a lower level.
I will be looking forward to that and have my parents tune in as well. So, the Roth is pretty complicated. Let's come back a little bit here, Richard. What other mistakes do people often make in this miscellaneous column?
Sure. I mentioned it earlier. The set and forget problem. It's funny, in 2008 that probably was the best strategy you could have done was not opening your statements and just not worry about that your portfolio went down 40% because a lot of people made a lot of changes thinking it was going to be Armageddon. The world's coming to an end and cashed out. What they missed out was in '09 when the market rebounded strongly. It took a lot longer for people to recover because they buried their heads in the sand and got out of the investments.
But let's just say normally, as you get older and get closer to retirement or things change, you really should reassess yourself and say, "Okay, is my risk the same as it used to be? Can I afford a big drop in the market five years before retirement? And if I do, am I willing to work a little bit longer? Should I take some of my 401k and allocate it to a short-term investment, which is not so correlated to the stock market? Just so if I do retire, I have a certain amount of money for a couple of years I can live on so the rest of the money can recover."
Those are the things you need to relook at. You also have to look at the fund selection. What's good today may not be good a year from now or two years. Investment managers change. The cost, you got to be conscious about the cost of the investments because you should get a value for what you're paying for. You should make sure that they're delivering on what they're telling you they're going to be doing. Again, doesn't mean the market drops, you lose money, you get out of it. It just says, "Okay, I chose this large cap growth manager because, historically, when the market was blooming, it trailed a little bit. But when it was down, it didn't lose as much. And that's what I was looking at. That's why I chose that investment. I had a reason why I bought it and I'm making them accountable during all investment cycles. If it's not doing it, let me go back and look at the other holdings and see if they're doing what I want done."
Again, also, relook at your allocation percentages. You want to make sure you're constantly increasing the amount of money you're contributing to. If you're a pretty high wage earner and you want to retire, let's say, at $250,000 of income a year, you probably need to max out and that still may not be enough. The 401k itself may not be enough to get you to retirement and understanding where you need to get to and how much you need to invest now to get there is really important to start planning.
What about fees and how that plays into the whole thing too?
Yeah. I mentioned a little bit about fees about a minute ago. Again, you pay for something and you expect something. There's a cost of everything. You can get really low cost investments in a 401k plan a lot of times. It depends on what you're looking for. If you're looking just to do as the S&P 500, maybe you're going to buy an S&P 500 index fund and the fees should be really, really low.
The best example where I can say you might want to pay a little bit more, as long as you get the value, is an international fund. There are companies out there, investment companies out there, who buy their research and their expense ratio might be lower. There's companies out there who invest in the international sector and they go out and they have managers overseas interviewing the CEOs. They're going through the financials. They're more hands on and I would expect that to be a higher expense ratio.
Now, if the return's not associated for what you're paying, I wouldn't invest in it. I would rather cut my costs and go with something cheaper.
Got it. Something that some people in my life are dealing with right now, who have not planned a ball for retirement, is needing money and worrying about taking a loan from the 401k. That can get into dangerous territory, right?
Jag, before we even touch there, I'm getting really concerned about you.
It seems like every single podcast we do, whatever you're not supposed to do in life, you've done it.
I said people in my life. I did not see me. Hashtag asking for a friend.
Okay. Okay. Just want to make sure. I'm a little worried about you. I don't want you moving in with me.
You got enough boys in your house. You don't need me too.
No, no. Not at all.
So, we're talking about loans. People do take 401k loans out there. They're are available. Some plans don't offer them. Some plans allow you to take one. Some plans allow you to take multiple loans.
First of all, let me explain how they work. The maximum loan you can ever take is $50,000 and it's based on a formula of, you could take out 50% of your vested balance. If you have a balance of $30,000, which is vested, the most you could take is 15,000. If you have a balance of a million dollars in your 401k, the most you could take out is $50,000.
That's the maximum. You have to pay the loan back within five years. They charge you interest. It could be about 1% or 2% higher than prime. It depends on how the 401k's set up with the loan.
The good thing is, when you pay the loan back, the interest, you're paying yourself back. The interest you're paying goes back to your own 401k. So, that's kind of nice.
Usually you have to have payments back to the 401k loan at least quarterly. If you don't pay the loan back, it becomes a distribution and a distribution, depending on your age, is first off, it's always taxed to you. But you could be assessed another 10% penalty for early withdrawal. That can be costly and you got to make sure how secure your job is. Just because you get laid off doesn't mean that loan is forgiven. You have 60 days, usually, to pay back that loan once you leave. Otherwise, they count it as a distribution. You will get a tax document called a 1099-R, which you have to report on your tax return.
It's going to sound confusing because a lot of people are used to the IRA rules. If you're under 55, you will get hit with a 10% penalty. If you're 55 and older and you have separation, and that loan's considered as a withdrawal, the 10% withdrawal is not charged to you.
I can only imagine, Richard, you're in a situation where you're a little strapped for cash. You have to take out one of these loans and you do, and you've got a plan to pay it back. And then all of a sudden, you get a pink slip and "Sorry, budget cuts. Your job is no longer needed." Then, you're in a panic because you've got to pay that back within 60 days or you're going to get whacked with the tax penalty for it. This is a really risky thing to do, I'd imagine.
I mean, you really need to be sure that this is where you want to take the money from, and there's got to be a reason why you're doing this, and you have to be prepared. What would happen if I lost my job?
The other misconception is people think, "Okay, I'm going to resign from my job. I'm going to go get a new job. I have a loan. And when I got hired for the new company, I'm going to roll my 401k over there and I'm going to take a new loan out to satisfy the other loan." You can't do that. It's not allowed.
No, it sounds like a bad idea anyway.
But I do want to mention this, there's a really nice exception if you're in the armed forces. A lot of soldiers, they come back and they work at jobs and they're still in the reserves. If they have a loan in their 401k plan and then they get called to go serve, while they're serving, that loan repayment can be paused.
There are special rules to that. You definitely want to check with the plan sponsor, the HR department. But again, if you're armed forces and you're called and you can't make those payments, just don't let them get defaulted. There are special rules for you.
Got it. Everything we've covered today, Richard, it really comes down to something that we do hit on in every episode, which is if you have any questions about something, seek professional advice, because it really is so important to speak to somebody who understands all the twists and turns and variations and numbers of all this kind of thing. The last thing you ever want to do is guess.
Correct. There's always professional advice out there. You could always go to a financial advisor. It's interesting. I just learned something. I was listening to another podcast. This was a podcast for advisors learning how to grow their business and things like that. We were talking about getting referrals within our own client base. One of the things they said, "Just because a client's using you doesn't mean they know all the services you offer."
In this case, a lot of people think a financial advisor always handles clients with money to invest. There are financial advisors out there where you can pay an hourly fee, a project fee, to help work one project for you, like this 401k plan. If you have a 401k and you don't want to make mistakes and you want to seek professional help, you can find a financial advisor out there who will help you with this on an hourly basis or a set fee.
There are some financial advisors who will help you start at square one and just make a budget.
Exactly. Like myself, I don't really care if someone goes to an insurance agent or anything like that, but I do insurance planning. I do cashflow planning, budget planning, debt reduction planning. Sometimes it's nice to hire an independent person who has no vested interest in additional sale.
Seek out professional advice if this is overwhelming, if the asset's large enough and you wanted a second opinion. Again, it's not something you have to sign an ongoing contract for. It could just be a one-time fee.
It's a conversation and if somebody wants to have a conversation with you, Richard, what are the best ways to reach you?
You can always find me at my website, www.ncfg.com. There's a tab called contact where you can schedule a phone call, a web conference with me. You can always pick up the phone, which is the way I prefer it. Number's (609) 924-2049, extension 126. Or shoot me an email at email@example.com.
Anyone listening, if there's any topics out there in the future you'd like to hear about, let us know.
Absolutely. They say that the NFL is a monstrous machine right now and there is no off-season to football, so I'm glad we've covered this fifth quarter quarterbacking and a lot other topics that we went pretty deep on and explained a lot of things. So please, if there's anything that you have a question on, reach out to Richard.
Always a pleasure, sir. We'll talk to you next time.
Richard Oring's branch office is 1 Airport Place, Princeton, New Jersey, 08540. The branch phone number is (609) 924-2049. Securities offered through Royal Alliance Associates Inc Member FINRA SIPC. Advisory services offered through New Century Financial Group LLC, a registered investment advisor, not affiliated with Royal Alliance Associates Inc. New Century Financial Group LLC and Royal Alliance Associates Inc does not offer tax advice or tax services. Please consult your tax specialist for individual advice. We make no specific comments or recommendations on any tax related details.