NEW YORK (MainStreet) — Is the best way to diversify a 401(k) simply to invest a small amount in every single option in the plan. That may seem to make sense, but it's a common misconception that many investors share. In fact, nearly three-quarters (74%) of 401(k) participants believe buying a bit of every investment offered is the right thing to do, according to a survey by MFS Investment Management.
However, many of the choices offered in a 401(k) investment menu can be redundant. By investing in a "little bit of everything," you could be duplicating your holdings rather than diversifying them. It's one of the five most frequent mistakes 401(k) investors make.
"Often retirement plans leave too many decisions up to participants, many of whom are ill-equipped to make well-informed decisions," says Ravi Venkataraman, global head of consultant relations at MFS. "Plan sponsors have a number of tools at their disposal that can help participants better invest for retirement. Creating simplified investment menus, implementing auto-enrollment and auto-escalation contribution plans, and offering professionally managed, diversified investment options will give participants the greatest chance of successfully investing for retirement."
In other words, if your 401(k) investment menu seems too complicated, get help – and complain.
Another frequent error that almost half of the participants surveyed (46%) are prone to make: tapping retirement savings for other financial needs -- like paying off debt or saving for college. Loans are an early distribution that can ultimately trigger taxes and penalties, as well as exclude funds from the potential for growth.
Other common misconceptions that can sink your 401(k) savings include:
- Nearly a quarter (23%) of plan participants surveyed thought that there is no additional benefit to contributing more than what is necessary to receive the employer matching contribution. That can limit your deferrals to single digits, while most financial experts say we should save 10% to 15% for life after work.
- Just 18% of participants believe that investing in target-date funds is the ideal way to diversify a 401(k) account. In fact, investing in just one diversified fund-of-funds like target-date or target-risk funds can be an excellent strategy.
- Nearly two-thirds (65%) of 401(k) investors believe index funds are safer than the overall stock market. And almost half (49%) thought index funds have better returns than the stock market. Wrong and wrong.
"Solving the retirement equation is within reach — it comes down to making steady and consistent contributions, investing in an age appropriate and well-diversified portfolio, refraining from taking premature withdrawals and maintaining a long term view," Venkataraman says.
--Written by Hal M. Bundrick for MainStreet