While downturns in the stock market often get the most attention from those worried about their retirement funds, something else may also be doing damage to your savings: 401(k) fees. Although retirement plans must be transparent about the fees they charge by law, most who contribute to them through their employers…Read more...
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ETFs and mutual funds can instantly diversify your portfolio, but they differ in how they're traded, managed and taxed. Here's what you should know.
Summary List Placement ETFs, or exchange-traded funds, and mutual funds have a lot in common. Both...Summary List Placement ETFs, or exchange-traded funds, and mutual funds have a lot in common. Both investment products pool investors' money into a collection of assets — typically stocks, but can be other assets like bonds, real estate, and commodities. Geared towards individuals, both offer a low-cost, diversified way to invest. But ETFs and mutual funds also hold important differences, especially in the way they're traded and managed, and what they charge and how they're taxed. What is a mutual fund? A mutual fund is a group of assets like stocks or bonds that you can purchase by pooling money with other investors. They are run by a professional portfolio manager who selects the fund based on a published investing strategy, so all the investors (and regulatory bodies like the SEC) know what they're getting when they invest. As of 2019, there are nearly 8,000 US-based mutual funds with total assets worth a staggering $21.3 trillion, according to Statista. Mutual funds offer plenty of benefits, from their affordability to the fact that professionals do the research for you. They also help diversify risk: You buy a fund with many different assets to avoid getting burned if any individual asset loses its value. Mutual funds are intended to be long-term, buy-and-hold investments. What is an ETF? Like a mutual fund, an ETF is an investment vehicle that combines money from many investors into a pool to invest in stocks, bonds, and other assets. Developed in the mid-'90s, ETFs are younger than mutual funds, but their number has exploded over the last 10 years. As of 2019, there are over 2,000 ETFs based in the US, with approximately $3.4 trillion in assets. Unlike mutual funds, however, ETFs trade daily on stock exchanges — which means that they can be turned over early and often, though they are also suited to a long-term investment strategy. If the aim of mutual funds is to beat the market, the aim of ETFs is often to follow the market. The majority of ETFs are index funds, meaning their portfolios mirror the holdings of a particular segment of the stock, bond, or commodity markets, be it a general one like the S&P 500, or a highly specific one, like biotech. The main differences between ETFs and mutual funds The diversification that ETFs offer makes them very similar to mutual funds. But when figuring out which is right for you, there are a few key differences worth knowing. 1. ETFs and mutual funds are sold differently If you have a brokerage account, either at a traditional full-priced broker, a discount broker, or an online trading app, you can buy and sell ETFs. You may have to pay broker fees per transaction, which can add up if you're buying small quantities often. In contrast, you buy a mutual fund either through a brokerage or through the investment company that owns and manages it. Time was when these investment companies wouldn't offer funds from other firms, only their own (does a Nike store sell Reeboks?). But over the last 10 years, as they've evolved into "financial services providers," some of the larger players — think Vanguard or Fidelity — have started offering other fund families, too. 2. ETFs and mutual funds are priced differently Mutual funds set their prices only once a day after the markets have closed. The price of a mutual fund share is technically known as the net asset value (NAV) since it represents the combined worth of the entire portfolio, not just a particular holding. ETF share prices are like any stock share price: continually changing throughout the day, based on buying and selling in the market. So they can be more volatile than mutual funds. 3. Mutual funds are actively managed, while ETFs are typically passively managed For the last couple of decades, mutual funds have offered active money management: financial pros — fund managers, backed by analysts — who pick and choose investments, trying to deliver market-beating returns. And ETFs have been the vehicle of choice for passive, auto-pilot investing — following an index or other group of assets, on the grounds that nothing outperforms the market overall. Recently that dichotomy has changed somewhat: You can find many actively managed ETFs, and if you want passively managed mutual funds, you can find those too. However, ETFs remain the darlings of robo-advisers and automated trading platforms. If you have an online investment account, like one from Betterment, Merrill Edge, or Vanguard Digital Advisor, odds are it's investing your money in index ETFs. 4. ETFs are cheaper than mutual funds Mutual funds are generally more expensive than ETFs. They require more human power to operate, which means they charge larger fees to pay their managers and commissions to pay salespeople. While they're spending less money on marketing than they have in the past, many funds still charge sales commissions called "loads." Other fees include redemption fees, exchange fees, account fees, and management fees. For example, in regards to equity mutual funds, the average expense ratio — as these fees are collectively called — is 1.24%, according to the Investment Company Institute (ICI). All these fees add up and cut into the total return of the fund. With ETFs the only commission you pay is to your broker, and since 2018 many brokers have waived transaction fees and commissions. Because they're so often passively managed, ETFs generally have lower expense ratios, as low as 0.03% The average is 0.49%, according to the ICI. 5. Mutual funds have higher minimums Mutual funds generally demand a minimum investment, ranging from a few hundred dollars to four — or even five figures. With ETFs, there is no minimum investment, and the price is whatever a single share costs on the exchange at that time. 6. ETFs have tax advantages ETFs are a little more tax-friendly than mutual funds, which also brings down the total cost of owning them. When a mutual fund manager sells an asset for a profit, the holders of the fund are liable for a portion of the capital gain on that sale, even if they still own the fund itself. Because the buying and selling that regulates the price of the ETF is done by outside parties ("authorized participants" in investment lingo) and not the fund itself, holders of ETF shares are not liable for capital gains unless they personally sell their shares at a profit. 7. Retirement plans prefer mutual funds When you have an employer-sponsored 401(k) or a 403(b) plan account, you're restricted to the funds offered by the plan manager. Those offerings overwhelmingly remain mutual funds. Although they technically can offer ETFs, many plans shy away from them due to compliance issues: Actively traded ETFs can come perilously close to being considered speculative investments, which are frowned on for retirement accounts. This is particularly true of 403(b) plans, which have more strict rules about what kinds of investments they can make. 8. You can unload ETFs faster Mutual funds being priced only once a day, at the end of the day, makes it hard to get your money out quickly — because you see the price of its underlying assets falling, for example. In contrast, you can sell an ETF any time during the trading day, like any stock. Of course, because they're so easy to buy and sell, you could be more likely to make a bad, emotionally driven move. The financial takeaway While they're both geared to individual investors, ETFs have become popular since the turn of the 21st century as a low-cost alternative to mutual funds. ETFs charge lower fees and have no minimum investment (other than the price of a single share). Still, outnumbering ETFs as they do, mutual funds offer more variety, and a chance to outperform the market. For investors who are saving for retirement, especially in an employee-sponsored 401(k) plan, mutual funds may be the best investment. For DIY investors, especially those who prefer to operate via an app or online, ETFs may offer the edge. Related Coverage in Investing: How to invest in mutual funds and grow your money for retirement, a bucket-list trip, or any other long-term goal An ETF is a type of investment that's easy to purchase and requires little management How to invest in index funds to build long-term wealth Warren Buffett thinks index funds are the best way for everyday investors to grow their money Experts say your office 401(k) is the best place to start investing. Here's how it works.Join the conversation about this story »
These expenses always eat away at savings balances, but as the pandemic drags on, savers should...These expenses always eat away at savings balances, but as the pandemic drags on, savers should be especially aware of how to keep them down.
A 401(k) is an employer-sponsored retirement plan that makes investing simple. To invest in a 401(k),...A 401(k) is an employer-sponsored retirement plan that makes investing simple. To invest in a 401(k), you need to make three decisions: how much of your salary you want to contribute, which funds you want to invest in, and what percentage of your contributions should go toward each investment. Generally, it's best to avoid funds with expense ratios above 1%, unless your company offers a contribution match that's higher than the fee. You can change your contribution rate and manage your investments at any time through your account on the plan provider's website. Coming soon: the Personal Finance Insider email. Sign up here » Though it's synonymous with retirement savings, the 401(k) plan is the best way to start investing, whether you're in your 20s or your 40s. A whopping $6.2 trillion was held in 401(k) plans by March 2020, accounting for nearly one-fifth of all retirement assets in the US, according to the Investment Company Institute. 401(k)s make investing simple by directing part of your salary into an investment account and paring down investment options. How to invest in a 401(k) 1. Find out if you've been automatically enrolled Many companies have an auto-enrollment feature in their 401(k) plans. Unless an employee opts out or changes their deferral rate, a predetermined portion of their pretax paycheck will be contributed to their 401(k). The default contribution rate varies depending on the company's plan specifics, but typically ranges from 2% to 5%. To find out if you're enrolled in your company 401(k), check your pay stub or contact your human resources team. 2. If not, enroll now If you're not already enrolled, your human resources team can give you the instructions or forms you need to do so. 3. Find out if you have a company match Ask your human resources team or check the 401(k) plan documents to find out if your company offers an employer contribution match and exactly how it is calculated. An employer match is free money. To qualify to get the free money, you'll need to defer some of your own salary into your 401(k). For example, an employer may promise to match 100% of its employees' contribution, up to 3% of their salary. That means if an employee who earns $60,000 a year contributes 10% of their salary ($6,000), the employer will contribute $1,800 (3% of $60,000) for the year. Minimally, many financial experts recommend contributing enough money to your 401(k) plan to qualify for your employer match before turning your attention to other tax-advantaged retirement accounts. Are you saving enough for retirement? Find out with this calculator from our partners: 4. Understand your company's vesting schedule Any contributions you make to a 401(k) are yours to keep, though you won't be able to access the money before age 59 and a half without incurring a penalty and/or paying income tax. That said, any contributions your employer makes to your 401(k), including matches, may not be yours right away. Your 401(k) plan's vesting schedule outlines exactly when your employer's contributions will be yours. You can contact your human resources team to find out about your company's vesting schedule. Most 401(k) plans have either cliff vesting or graded vesting. A cliff means that contributions made by the employer won't be the employee's to keep until they've worked at the company for a specific period of time, usually two or three years. Graded vesting means that a specific percentage of the employer's contribution vests each year the employee is at the company. For example, your company's 401(k) plan may have four-year graded vesting — after one year of service, 25% of their contribution is yours; after two years of service, 50% of their contribution is yours; after three years of service, 75% of their contribution is yours; and finally, after four years of service, 100% of any past and future contributions are yours to keep and invest in your 401(k). If you leave the company before your vesting period is up, you'll lose any portion of your employer's contribution that isn't already vested. 5. Choose your deferral rate A lot of people get caught up deciding how much to contribute to their 401(k), but anything is better than nothing. The good news is your deferral rate — the amount of your paycheck that's deferred from income taxes — is not set in stone. Most plans will allow changes to the deferral rate (also called a contribution rate or savings rate), at any time, though it could take up to a month to go into effect. In 2020, the IRS allows employees to contribute $19,500 to a 401(k), plus an extra $6,000 for folks over 50. To max out your 401(k) this year, you'd need to contribute about $812 every paycheck (assuming 24 bi-monthly paychecks over the course of the calendar year). 6. Choose a beneficiary You'll also need to name a beneficiary — the person who would inherit your 401(k) in the event of your death. It can be changed later if needed. 7. Browse investment offerings and pay attention to fees The investment options in a 401(k) are carefully selected by the employer. Most 401(k) plans offer between eight and 12 investment options, which can be a mix of mutual funds, stock funds, bond funds, and even annuities. There are two general types of fees you will see in your account: Account management fee charged directly by the 401(k) plan provider Fee charged by the mutual funds and ETFs in your 401(k) account (expense ratio) If you're investing in your 401(k), the account management fee is unavoidable. If your provider is charging a management fee above 1% of your account assets, you may consider directing your savings elsewhere, such as an IRA with lower fees. However, it could be worth contributing if your employer offers a match that is higher than the provider's management fee. Most mutual funds charge a management fee, too. This is listed on each investment fund as the expense ratio, or the fee rate as a percent of assets. Again, look for funds with an expense ratio below 1%, otherwise the fees could start eating into your returns. 8. Choose your investments Aside from fees, there are two important factors to consider when choosing specific investments: your time horizon (how many years you have until retirement) and your risk tolerance (how much risk you can withstand). If you have decades to invest before you need retirement income and are fairly risk tolerant, you may choose a fund with more stocks, as they're considered riskier than bonds. Some 401(k)s offer "all-in-one" target-date funds that automatically rebalance to fit into your time horizon. You may see them labeled as "Target" or "Retirement Fund," plus a year. For example, a "Target 2040" fund is made up of a blend of investments that assumes retirement in the year 2040, so investments will need to be as conservative as possible by that time. You don't have to choose a target-date fund that matches your actual retirement age. 9. Choose how much of your contributions should be invested in each fund As you choose your specific investments, you'll decide how much of your contributions will go toward each investment, usually expressed as a percentage. If you only choose one fund, 100% of your money will be invested in that fund. If you create a portfolio with three different funds, you can decide what percentage of your contributions will go toward each fund. 10. Log on to your account through your plan provider's website to periodically increase your contribution rate and manage investments You can change your contribution rate and manage your investments by logging on to your account through your plan provider's website (e.g. Vanguard, Fidelity, etc.). Most experts suggest increasing your 401(k) contribution rate at least once a year, or each time you get a raise. Related Content Module: More Savings CoverageJoin the conversation about this story » NOW WATCH: Pathologists debunk 13 coronavirus myths