For most people, contributing for a company 401k plan or other pre-tax retirement account should be Step 1 when planning a financial future.  Yet it’s amazing to me the number of folks who mismanage their pretax investment options and waste a wonderful opportunity to potentially add hundreds of thousands of dollars to their wealth.

So here are 10 tips on how to be a successful 401k investor:

1.  ENROLL & PARTICIPATE.  This is probably the most important step.  If you don’t start putting a slice of your paycheck in your plan, you will never be given the benefit it offers.  Think about it.  Outside a 401k or other pre-tax equivalent, most people have to earn at least $1.25 to invest $1.00.  For each dollar you invest in your 401k, your take home pay is reduced by only $0.75 (assuming a 25% tax bracket.)

2.  BE AN OWNER, NOT A LENDER.  The mutual funds in your 401k will likely invest in ownership positions (stocks, real estate, precious metals, etc.) or lending positions (bonds, money market accounts).  Conventional wisdom says that you have a mixture of both - a strategy I find absurd.  When you invest in lending positions you are guaranteed to lose buying power.  You will either lose it very slowly through inflation or possibly overnight if the dollar ever becomes worthless.  I recommend keeping your 401k assets fully invested in ownership positions which are not tied to the value of the dollar.  The volatility you will experience is a small price to pay for the long-term returns and the real world financial safety. 

3.  DIVERSIFY YOUR OWNERSHIP.  A diversified ownership portfolio will allow you to own shares of large, mid, and small company stocks.  Domestic and international stocks too.  As a hedge against inflation and geopolitical risk, I’d also keep a small chunk allocated to gold-related investments.  Your 401k may not offer all these asset classes so diversify as well as you can with the asset classes your are provided.

4.  DEMAND THAT YOUR PLAN OFFER THE HIGHEST QUALITY INVESTMENT OPTIONS.  I see the investment options offered in many plans and too often I come away unimpressed.  If your plan doesn’t give you enough asset classes to create a diversified portfolio or if all the options come with high fees and mediocre returns, ask the trustees of the plan to change this.  It’s likely their assets are also in the plan so you’ll be given credit for helping their bottom line as well as your own.

5.  LIMIT YOUR INVESTMENT IN COMPANY STOCK.  This is an easier lesson to swallow following the days of Enron and WorldCom.  So unless you enjoy the thrill of riverboat gambling, I don’t recommend having the bulk of your money tied to the performance of any one company.

6.  NEVER BORROW AGAINST YOUR 401K.  It will defeat the benefit that your plan offers and any loan repayments must be paid back with after-tax dollars. 

7.  DON’T CASH OUT YOUR 401K IF YOU LEAVE YOUR COMPANY.  If you leave a job you will likely have a right to your 401k assets by by taking them in cash means you will be hit with a tax bill and possibly a 10 percent penalty if you are not yet age 59 1/2. 

8.  IF YOU ARE AT LEAST 59 1/2, ROLL YOUR ASSETS INTO AN IRA.  Your 401k may not offer this feature but if it does, take advantage of it while you are still working.  This way you have access to the entire world of investments and not just the options offered in your plan.

9.  REBALANCE REGULARLY.  At least once a year, take a few minutes to rebalance the assets in your plan.  Sit down and calculate the current percentages of the mutual funds you own.  Some percentages may be much higher and some much lower when compared to your initial allocation.  Many plan providers now allow your rebalancing to be done automatically on an annual, semi-annual, or quarterly basis. 

10.  COMMIT TO MAXING OUT YOUR PLAN.  I know not everybody can do this but as the very least, invest the maximum amount you can possibly afford.  Then every time your pay increases, up your contribution amount until you have hit the maximum allowed.  I promise you won’t be sorry.

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