Are You Making This Subconscious Investing Mistake With Your 401(k)?

I am always fascinated by anything having to do with money and our mindset, so this research paper on how people select investments in their 401(k) got me. A study has shown that regardless of industry, company size or any other factor that might determine an employee population’s investing knowledge, people are much more likely to choose the investment funds in their 401(k) that are closer to the top of the list than the bottom. This might explain why there are very few or no mutual fund companies that start with the letter Z, but it’s also a serious thing to consider as a 401(k) investor. 

A Mistake Even Professionals Make

I know that the first time I had to select investments for my 401(k), I looked at the list which was 20 funds long, and literally put 5% into each. I share the story all the time during investing workshops to show that even someone with a CPA license who was working for a large financial services company at the time had no effing clue what I was doing. I mean, I guess at least I was spreading out among every fund and not giving preference to the ones listed at near the top, but my point is that it’s easy to mess it up, although it doesn’t have to be.

Avoid Making the Same Mistake

The simplest way to avoid making sure you’re not making this mistake is to see if your plan offers a target retirement date fund. Some people – in fact most people that aren’t just picking the top 3 on the list – are opting just to select this option, which is designed to be a “set it and forget it” option. In fact, that’s how I invest my own 401(k) at my current job.

Try This Hack If You Want a More Customized Approach

However, if you’re feeling like you want to be more hands-on and choose your funds appropriately, I still find target date funds to be helpful in that they show an appropriate allocation for somebody your age with moderate investment risk tolerance. So if you want to be more hands-on, that most likely means you are a more aggressive or more conservative investor than the average person, so you could take that target date fund allocation and adjust it to be more in line with your investing personality.

In other words, if you’re in your early 40’s like me, you’re probably looking at a Target Date 2040 fund, which will likely have a broad allocation of 80% stocks and 20% bonds. To me, that’s a starting point, then if I wanted to be more aggressive, I’d simply increase the percentage of stocks and if I wanted to be more conservative, I’d increase the bonds. But I like having that general suggestion of what the investing industry considers appropriate for the average person looking to start spending down their savings around the year 2040.

Figuring Out Your Investment Risk Tolerance

How do you know if you’re a more aggressive or conservative person? Here’s a simple litmus test: if the stock market were to fall 40% tomorrow and stay that way for two months, and all you heard about on the news is how the stock market had fallen, what would you do? (Brief disclaimer: I am assuming anybody reading this or taking this “test” has at least 10 years to go until the goal they’re investing for, which therefore makes it within reason to be investing in the stock market.)

If you would close your eyes and stop looking at your portfolio and ride it out, then I would say that would make you a more aggressive investor. If, on the other hand, you would immediately liquidate your account to guard against any further falling, that might make you a more conservative investor. Finally, if your answer is that you would’ve preferred that your account only felt 30% knowing that some people’s fell 40% and were comfortable with that, then I’d say you’re probably a moderate investor.

Now, this is not a perfect test. And it’s by no means investment advice, but in my experience as a financial wellness coach, this is what I see among the people I work with. So if you’re the person that’s going to panic when your account value falls in line with the market, you probably shouldn’t be as much in the market as the person who understands and is OK with that fluctuation.

Check Your Bias for the “Top” of the List

All that to say: make sure you’re not just picking your 401(k) investments based on where they fall on the list of funds you have to choose from. Instead, take some time to educate yourself on what the most appropriate mix would be for where you are in your career and how you feel about investment risk. There are tons of resources out there to help with this, so take advantage.