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As we approach the end of the year, many 401k investors are getting ready to do some housekeeping to their retirement portfolio. But thanks to a volatile 2010, the results on 401k statements could be very different from investor to investor — and may even prompt a desire to take a vastly different 401k investing strategy in 2011.

But before you dump your mutual fund holdings due to losses or double down in a successful mutual fund with hopes of bigger gains, investors should take care to avoid some of the most common 401k mistakes. Bad moves made now are compounded over time as you save for your retirement decades down the road via mutual funds and your 401k.

So before you make a change in your mutual fund portfolio that you may regret, keep in mind these seven costly mistakes of 401k investing.

It’s fine to have a favorite mutual fund, but just make sure that your affection for the investment is rooted in reality. Too often, 401k investors will look at past returns or untapped potential as a reason to fall in love with a mutual fund — even when quarterly statements tell a very different story.

Take one of the flagship mutual funds, Fidelity Magellan (MUTF: ). From early 2003 to early 2006, investors were rewarded with eye-popping returns of almost 50%, and assets under management were cruising at around $50 billion. The fund was popular and highly profitable, and coworkers could pat each other on the back for choosing this great fund that was so good to them.

Except Magellan’s gains in that timeframe essentially track the major indexes. And over the last five years as the bull market has faded, the fund is off 35% while the major indexes are flat. What’s more, for two separate periods in 2009 FMAGX had Morningstar’s worst rating of just one star.

Breaking up is hard to do — but sometimes it’s for the best. Don’t let lust cloud your judgment and erode your 401k’s value.

Let’s get one thing straight: Mutual funds, by nature, are inherently diversified. While it’s true that there are various flavors of funds and that you can get burned if you put all your eggs in one basket, there is rarely ever the need investors to hold more than a handful of mutual funds in his or her IRA.

Take a fund like the Vanguard Total Stock Market Index (MUTF: ). The fund puts nearly all of its assets in individual stocks, save for a little cash as trades are executed. As of this writing, the top position is Exxon Mobil (NYSE: ) with a whopping 2.5% of assets. That’s hardly a majority position. As a result, the fund consists of some 50 stocks — and chances are that at least a few of those same companies will appear in any other blue chip mutual fund you choose.

That’s not to say there’s anything wrong with making a play on a specific sector or a specific strategy. But don’t fool yourself into thinking that a higher number of funds is always better. You could, in fact, just be bleeding cash in fees without boosting your diversification at all.

In any type of investing — be it stocks, options or mutual funds — it’s easy to get caught up in the thrill of a winner and to keep pushing for more gains. But saving for retirement isn’t a game. And as such, you should make a clear line between what is necessary for your nest egg and what would be nice to have if things go your way.

For instance, let’s say you watched the financial sector bounce back dramatically from the March 2009 lows — with Citigroup (NYSE: ) and Bank of America (NYSE: ) soaring 350% in six months, with JP Morgan Chase (NYSE: JPM) and Goldman Sachs (NYSE: ) tacking on 80% gains in the same period. So to capitalize, you found a mutual fund to play this strength — such as the T. Rowe Price Financial Services Fund (MUTF: ), which doubled during that same March to September period in 2009 that was so good for bank stocks.

Well, outside of a short-lived spike this spring, PRISX has been dead money. Keep that in mind before you go chasing the latest “flavor of the month,” such as gold mutual funds that have done so well lately.

Chasing the hottest mutual fund of the moment can be bad news, but that’s not to say 401k investors should just set their retirement portfolio and forget it. One of the worst things for your mutual fund portfolio is to just let it sit there for 30 or 40 years until it’s time to retire.

Some of the pitfalls are obvious — missing out on opportunities and staying in bad funds are at the top of the list. But there are many other reasons to stay on top of your mutual fund investments. An aggressive fund that is wildly profitable could leap from 10% of your nest egg to 20% or 30% in a few years. Those profits should be reallocated before they disappear. Or a great fund in your portfolio may announce a change in management — meaning the future holdings and strategy of this investment won’t be what you signed on for.

Yes, 401k investing is long term and is not meant to be treated as a day-to-day trading exercise. But that’s no reason to sit on your hands for a few decades and hope for the best. Take an active role in your retirement and read those quarterly statements carefully!

When investors lose money, they get angry. And one of the most common ways to vent that anger is to “punish” the investment that burned you by selling it.

The only thing is, mutual funds — as well as stocks, bonds and any other asset class — don’t have emotions, and it’s impossible to teach them a lesson. Making an emotional decision to sell a stock or a mutual fund may wind up costing you more money in the long run.

This is the eternal dilemma for 401k investors sitting on a loss. As Kenny Rodgers put it, “You gotta know when to hold ’em and know when to fold ’em.” And while there’s no simple answer on when you should give up on an investment that has lost you money, one thing is certain: Your decision to sell should be based in fact — not anger.

We’ve all heard our neighbors or co-workers brag about a great investment that they made and felt left out. The wound is even deeper when we were given a tip from a fellow armchair investor several months ago and wrote it off as a foolish move — only to eat our words.

But if you think the solution is to belatedly jump into that investment you missed out on, think again. Not only does past performance fail to guarantee future returns, but you may be abandoning your long-term goals for a short-term pick-me-up.

By way of example, consider the Tocqueville Gold Fund (MUTF: ) is one of the top-performing mutual funds lately. Year-to-date, it is up over 40%, and in the last 10 years, it’s up a staggering 670%. That’s great, but it’s important to keep in mind that gold funds as a rule have some of the highest standard deviation and beta readings on Wall Street. Or put another way, the ride down can be just as quick as the ride up. So if you’re a conservative investor, this mutual fund is bad news no matter what the profit potential.

Keep this in mind when you envy your neighbor’s returns. Not only may the fund’s run be over, but its strategy may be outside your own personal investment goals.

Pride has no place in 401k investing. It’s easy to continue to pump money into a loser on the premise that if it was a good value at $25 per share, it’s even better at $20. Also, I’m sure we all have used some variation of how “the market is going down, so everything is going down.” And let’s not forget the old excuse about how we’re just waiting to get back to square before we sell.

The fact is that if you sell a bad mutual fund at a 20% loss and move that money into a fund that gains 20%, you’re even overall. So the only question you should ask yourself is whether you truly think that losing mutual fund is your best bet right now — or whether there’s a better investment option.

It can pay to swallow your pride on a bad investment. Otherwise, you just may wind up digging a deeper hole.