Mutual Funds
Let's try to fully understand mutual funds as this is where the majority of U.S. Household money is invested. Now that you have some basics down, we will take it up a notch. As stated earlier, there are thousands of funds spread across many different categories. We talked about stock funds and bond funds etc. What we want to look at now that you understand risk and reward is the following: Funds that reach for greater returns are termed aggressive growth funds and those that strive for safety are termed conservative growth funds. Funds that have bond holdings are termed income funds. A mixture of the above would be termed a growth & income Mutual Fund. When you first begin to invest, presumably in your twenties or thirties, you have a long time horizon until retirement. That being the case, it would be prudent to have your mix of funds heavily weighted towards the aggressive growth side of the spectrum as you want to be able to max out your returns. You would have plenty of time to weather out a storm on the financial front. As you get older, your mix of funds should reflect that you cannot afford to be as aggressive as when you were younger because if you were to sustain a market retreat, you would have less time to recoup your losses. Taking this idea one step further, as you reach retirement or are in retirement, you would want minimum exposure to aggressive growth funds and maximum exposure to income funds. E.T.F.'sExchanage Traded Funds a.k.a. ETF's, are a relatively new type of security that one can invest in. They are made up of a basket of stocks and or bonds just like a mutual fund but they can be traded all day long just like a stock. Mutual funds can only be traded at the end of the trading day when the fund manager calculates the Net Asset Value (NAV) of the fund. This determines the share price and hence what you will pay for that fund. Traditionally, ETF's mainly mirrored indexes like the S&P 500 or the Precious Metals index, but now the rules have been relaxed and there are hundreds of different ETF"s which allow the investor to tailor them according to their risk tolerance. ETF's are becoming increasingly popular as an investment vehicle because of their low cost, tax efficiency and stock like features.InflationSo now you might be thinking “Why not sell out of stocks, mutual funds and etf's all together if they are too risky when I am in retirement and have basically no time horizon left to recoup any losses”. The answer is a complex one but can be summed up in one word. INFLATION.That nasty word that keeps the prices of everything going in one direction...up. The thinking is that with people's life expectancy getting longer all the time, it is not uncommon to live 20 years or more in retirement (65 to 85). With that being the case, you need to have some stock exposure in your portfolio to keep up with inflation as history has shown us that over time, stocks outperform bonds. You will need to have a small portion of your entire portfolio invested in stocks in addition to bonds if you intend to keep pace with inflation and not run out of money before your time.
Pay Yourself FirstIf you recall from the 9 Steps to Financial Freedom, step one: Pay yourself first, you now know that with this 10% that you are paying to yourself, you are going to be investing for the long haul and probably in mutual funds. What I would like to show you now is the difference between investing in a tax deferred account like a 401(k) or an IRA versus choosing not to open up one of these tax advantaged vehicles but instead investing with after tax dollars.Let's say that you start at age 20 putting away $5,000.00 per year and you do this religiously till retirement at age 65. That's 45 years of savings or $225,000.00 input from yourself. Let's also assume that you are able to capture a modest 8% return for your efforts. In the first case, you are funding your 401(k) and or your IRA. Your $225,000.00 grows to almost $2,000,000.00 in a tax deferred account. This same $225,000.00 grows to only $1,437,609.00 in a taxable account. You could have accumulated over 25% more just by your choice of account! Tax deferred accounts are the way to go...wouldn't you agree?
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Go to Investment Guide from Mutual Funds
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