While educating yourself on retirement investing strategies,these two terms likely come up often. And there are key reasons why. Keepreading to learn more.
What is a mutual fund?
A mutual fund is an investment opportunityallowing you to pool your money with that of other investors to purchasestocks, bonds, and other securities that you could not afford to invest inalone.
The higher your income, the more likely you’reinvesting in mutual funds: 84 percentof mutual funds are owned by the richest 10 percent — a fact that speaksvolumes about the financial possibilities of mutual funds.
What is a 401(k)?
A 401(k) is an employer-sponsored, tax-deferredretirement plan. The employer chooses the 401(k)’s investment portfolio, whichoften includes mutual funds. But amutual fund is not a 401(k).
What about taxes?
401(k) plans are usually tax deferred, meaningcontributions are taken from your pretax income. Taxes are only applied whenmoney is withdrawn from the account, typicallyduring retirement when you are likely in a lower tax bracket.
Mutual funds, in contrast, are generallypurchased with after-tax dollars. Income from the fund, including dividends andinterest, is taxable, as are any earnings when investments are sold.
Which should you invest in first?
If you prefer tax-deferred plans, your 401(k)should be maxed out first. This is especially true if your employer matches orcontributes to your 401(k). If you don’t takeadvantage of that match, you are basically throwingaway free money.
401(k)s have an annual contribution limit of$19,000. In contrast, there’s no limit to the number of mutual funds you canpurchase, making mutual funds an effective way to diversify your retirementportfolio.
The bottom line
A 401(k) and mutual funds can both play vital roles in your retirement savings plans. But don’t stop here! Head on over to our comprehensive guide to explore the many retirement plan options available to you.
FAQs
401(k) plans are usually tax deferred, meaning contributions are taken from your pretax income. Taxes are only applied when money is withdrawn from the account, typically during retirement when you are likely in a lower tax bracket. Mutual funds, in contrast, are generally purchased with after-tax dollars.
Is it better to invest in mutual funds or 401k? ›
A 401(k) provides tax benefits and an opportunity for an employer match, boosting retirement savings. On the other hand, mutual funds offer diversification and access to professional management.
What are the pitfalls of mutual funds? ›
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
What is the biggest drawback of a 403 B plan compared to a 401 K plan? ›
Investment options: 403(b) plans only offer mutual funds and annuities, but 401(k) plans offer mutual funds, annuities, stocks and bonds. Because 401(k) plans are more expensive for the company, they usually offer a wider range and sometimes better quality of investment options.
Is there a better investment than mutual funds? ›
Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Are mutual funds best for retirement? ›
This diversification helps spread risk across various assets, which can be crucial for long-term retirement planning. With a single mutual fund investment, an individual can gain exposure to a wide range of securities, reducing the risk associated with investing in individual stocks or bonds.
Why 401k instead of investing? ›
The tax advantages of a 401(k) plan combined with an employer match are a winning combination. “If you invest your retirement directly into stocks instead of a retirement account, you will be subject to taxes on the dividends and capital gains when you sell the stocks.
Who should not invest in mutual funds? ›
Lack of Control. Because mutual funds do all the picking and investing work, they may be inappropriate for investors who want to have complete control over their portfolios and be able to rebalance their holdings on a regular basis.
Are mutual funds risky now? ›
In the category of market-linked securities, mutual funds are a relatively safe investment.
Are mutual funds safe for long term? ›
Is a mutual fund safe? The safety of a mutual fund depends on the type of assets it holds and the market conditions. For example, a mutual fund that invests primarily in government bonds is generally considered to be safer than one that invests in stocks.
Traditional IRA
Traditional individual retirement accounts (IRAs) offer more flexibility and tax benefits than 401(k) accounts, making them one of the most popular 401(k) alternatives. Individuals can contribute up to $7,000 a year and defer tax payments until the money is withdrawn in retirement.
What retirement plan is better than a 401k? ›
If you want the best possible selection of investments, then an IRA – especially at an online brokerage – will offer you the most options. You'll have the full suite of assets on offer at the institution: stocks, bonds, CDs, mutual funds, ETFs and more.
Why is 403b bad? ›
Few investment choices: Up until recently, 403(b)s offered only variable annuities. While this is no longer the case, this type of account offers more limited investment options than a 401(k) or an IRA. High fees: Some 403(b)s charge higher fees that can eat into your profits, although this isn't true of all of them.
What is the best mutual fund to invest in in 2024? ›
When returns matter!
| Name of the mutual fund | Type of fund | 5-year returns (in %) |
|---|
| Nippon India Multicap Fund | Multi-cap fund | 128.22 |
| Mahindra Manulife Multi Cap Fund | Multi-cap fund | 113.68 |
| Bank of India ELSS Tax Saver | ELSS fund | 116.05 |
| SBI Long Term Equity Fund | ELSS fund | 115.88 |
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One selling point is that they allow you to hold a variety of assets in a single fund. They also have the potential for higher-than-average returns. However, some mutual funds have steep fees and initial buy-ins. Your financial situation and investment style will determine if they're right for you.
What is the average return on mutual funds? ›
| Average Mutual Fund Returns |
|---|
| Category | 2021 Return | 10-Year |
|---|
| U.S. Mid-Cap Stock | 23.40% | 13.12% |
| U.S. Small-Cap Stock | 24.19% | 12.74% |
| International Large-Cap Stock | 9.72% | 7.85% |
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All investments carry some risk, but mutual funds are typically considered a safer investment than purchasing individual stocks. Since they hold many company stocks within one investment, they offer more diversification than owning one or two individual stocks.
Should I put my money in a mutual fund? ›
All investments carry some degree of risk and can lose value if the overall market declines or, in the case of individual stocks, the company folds. Still, mutual funds are generally considered safer than stocks because they are inherently diversified, which helps mitigate the risk and volatility in your portfolio.
At what age is 401k withdrawal tax free? ›
401(k) withdrawals after age 59½
Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.
