For those of us lucky enough to have a job, and, better yet, a job that offers a retirement savings program like a 401k or 403b option, we have been introduced to mutual funds. Faced with a bewildering array of choices, many just throw their hands up and do nothing. That means their retirement savings are left in the default option, which is often a money market fund. For those who have done just that, they are feeling like geniuses these days. When colleagues complain about their 401ks getting crushed, holding at even sounds great. For now.
However, if your retirement is not around the corner, earning less than 1% in a money market fund does not keep pace with inflation, currently at about 3.5%. So even though your balance is holding its own, the spending power of your retirement savings is getting chewed up year after year. So what is one to do? Like your mother would say: Your homework! Like any consumer, you need to know what you are getting, what it is costing you, and most importantly, whether it is a good fit for you.
Types of Mutual Funds
Mutual funds are professionally managed pools of capital most commonly invested in stocks, bonds or cash equivalents. Mutual funds can also be invested in more exotic securities, but these types of funds are seldom offered in retirement plans. In an employer-sponsored plan, the offerings are often selected to give employees a sufficient number to choose from, including “Target Date” funds that are pegged to your retirement date.
Target Date funds allocate a percentage to stocks and bonds and cash within the fund itself. For younger employees there is a higher allocation to stocks that gradually moves more to bonds and cash as they near retirement. If you have no interest in digging deeper, choosing a Target Date fund is a better alternative to keeping your contributions in a money market fund. They may lose value in a down market, but should grow by more than inflation over the long term.
For those who have the inclination to spend a little more time on the homework part, you can customize a selection of mutual funds for yourself, based on your age, your tolerance for risk, and the types of funds available to you. Often, there are resources provided by employers that will guide you to an appropriate allocation. A good way to start.
Mutual Fund performance is how much the fund has grown in value over a period of time. Mutual fund performance expressed as an average annual percentage is required to be shown after all fees and expenses incurred by the fund have been deducted from its return. It is natural to gravitate to the funds with the highest returns, but that might be a mistake. You are much better off choosing a fund that fits your needs rather than what it has returned historically. Like it says in the fine print, there are no guarantees that this performance will be repeated in the future. And very often, the opposite is true. Last year’s winners are often next year’s dogs.
If you are selecting mutual funds outside of your retirement plan, there are independent services that rate funds on a variety of factors in addition to performance. Most funds show these ratings as part of their information package.
If you can spare the cash, even if it is a small amount initially, making a contribution to your retirement plan is a wise move. And, if your employer matches a portion of that contribution, that is a “guaranteed return” on your investment. Two words seen together as rarely as “ budget surplus” these days.
Ina Fernandez has over 20 years of investment experience, and is currently Managing Director at Liberty Capital Management, Inc. Ms. Fernandez also serves as Board President for the Coalition on Temporary Shelter (COTS).