Don't put all your eggs in one basket
One of the most popular retirement savings vehicles is mutual funds.
There are trillions of dollars invested in them in the United States. Several things have led to their explosive growth over the last few decades. When our parents and grandparents retired, they received defined benefits as a pension.
All of the investment risk was assumed by the company. Many companies have switched retirement plans to 401(k)s. This has required people to make choices for themselves and thus become more familiar with possible investment options.
Cable television has also helped to fan their growth. When there were just three major networks, financial information was not usually part of programing. With hundreds of channels today, there are several that broadcast financial information all day. These channels promote their advertisers, which are mostly related to equity investments. They do not discuss all types of investments equally. The depth of coverage they provide can be both useful and confusing depending on your degree of understanding.
Another development that has led to the growth of mutual funds is the internet. Information is available at our fingertips. People are used to finding information on everything. Research and accessibility makes us feel confident in our choices.
We are told that mutual funds offer two distinct advantages over selecting our own individual equities – professional management and diversification. You should not have all of your eggs in one basket. At one time Enron was one of the fasting growing stocks in the country. Their employees had most of their 401(k) money invested in the company. When Enron went bankrupt, the employees lost all of their savings.
Some mutual funds rely very little on professional managers. These are called index funds; they simply mimic an established index by copying the stocks in the index. When the whole market is rising, they tend to go like all boats rising during high tide. When the market is moving sideways or choppy like we are seeing now, more actively managed funds perform better if they are disciplined.
Many funds do not show this discipline. They drift their portfolios to follow the newest trends and are not willing to take profits off the table. Often like individual investors, they get greedy.
Mutual funds work best for investors who do not have many assets saved and want equity exposure. If you can afford $100 dollars a month, you can begin a mutual fund. Putting the same amount of money in every month regardless of what the market is doing will slowly grow your savings.
This is known as dollar cost averaging. When following this strategy you must have sufficient time until you need these assets and you must continue to make the deposits. Remember, your market money must always be in the market and your non-market money can never be in the market.
No one can time the market, including you.
Most people invest in mutual funds through a 401(k). Most plans require you to keep your money in the available choices and do not allow you to do an in-service transfer. That is when you can roll some of your money outside into an IRA to have more choices. Funds in 401(k)s can be very expensive. In addition to the mutual fund cost, there are charges to run the plan. This is one reason that you should not leave money in an old plan at a former employer.
Next week, we will look at some of the reasons that you may not want to be in mutual funds if you roll over a former plan or have already built up your savings. Some of the advantages that you think you are receiving may actually work against you. We will also look at very common areas make it extra expensive to own mutual funds.
Gary Boatman is a certified financial planner and a local businessman who serves as president of the Monessen Chamber of Commerce.