A mutual fund is an investment vehicle that uses a collection of money, sourced from thousands of people, that is then invested across multiple securities such as stocks and bonds, and more. When you purchase a mutual fund for retirement, you’re basically putting your money into several investments at once: many mutual funds contain over 100 separate securities (stocks, bonds, or other investments).
Each mutual fund has a different recipe of assets, comes with its own degree of risk and reward, and is managed by a sponsoring company, each of which has their own track record of performance. Weigh each of these carefully in light of your retirement strategy when investing for retirement.
How do mutual funds work?
A professional portfolio manager—or a team of them—watches market movements and decides what and when to buy and sell. Five common types of mutual funds include:
- Bond funds invest in several different bonds, which are basically loans that investors make to companies, governments, and other institutions. Investors gain from the interest, but don’t acquire ownership rights. The maturity dates of the bonds are typically staggered to keep returns steady over time.
- Stock funds invest in baskets of stocks. There are an endless variety of stock funds. So-called growth funds focus on riskier companies, in the belief that greater risk leads to greater reward. Income funds focus on stocks that pay out larger dividends. Sector funds focus on specific industries, such as electronics or real estate.
- Index funds aren’t like most mutual funds. An index fund is constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index. Your typical mutual fund is actively managed by a professional who tweaks the portfolio on a daily basis, always trying to beat the market. Index funds, in contrast, don’t try to beat the market: they simply try to match or track it, by holding all stocks within the index. This approach is based on research findings that suggest that even the best portfolio managers don’t perform significantly better than the market average over many years. Index funds are also cheaper to invest in because they’re passively managed, saving you fees.
- Money market funds are extremely liquid and focus on shorter terms, meaning you can cash them out easily.
- Target-date funds, also known as lifecycle funds, may be more valuable to those approaching retirement. They’re designed to cover an extremely broad selection of stocks, bonds, and cash, and shift from more aggressive stocks to more conservative bonds as you age.
Benefits of mutual funds
Mutual funds are one of the more versatile investments you can make. Since they cover a great number of securities, they’re well diversified and therefore less risky. They allow you to easily spread your eggs across hundreds of baskets, so to speak, as part of a group of investors. It’d be very difficult to dip into so many assets as an individual.
Mutual funds are also relatively liquid, which is particularly valuable to retirees who may face unexpected expenses.
Risks of mutual funds
Although their diversified nature helps mitigate risk, mutual funds are still only as secure as their underlying investments. Pay attention to funds that may not be as diverse as they seem—funds that focus on particular industries or locations, for example, are susceptible to market-wide downturns, which could cost you much of your investment.
Past performance is never a prediction of future returns, so don’t get star-struck by a stellar short-term record and overinvest. A responsible retirement portfolio contains several types of investments and guaranteed income; mutual funds aren’t fixed-income products that deliver consistent or guaranteed returns.
Mutual fund considerations
The wide variety of mutual funds offer an investment strategy for practically any type of investor from conservative to aggressive. Remember, if you prefer to have someone else manage your investment strategy as you approach retirement, target-date funds are specifically designed to intelligently adjust toward more conservative investments as you approach retirement. However, because they require more management, target-date funds may incur higher fees.
Consider scheduling a retirement income checkup to discuss options for your next steps as you plan for retirement.