My goal this year is to not only build my savings accounts, but to build my total wealth which includes investigating possibilities such as mutual funds. Though many people prefer IRA’s as a supplement to a traditional retirement fund, such as a 401(k) or a 403(b), there are certain restrictions and limitations with them that I don’t necessarily think is best for us. Some restrictions include you must be married and filing jointly, there’s a limit on how much you can deposit in a year, and there are penalties for withdrawing before age 59 1/2. Instead, mutual funds will offer me a bit more flexibility, allow me to withdraw at anytime, and doesn’t limit the amount of investment in a given year. *If I’m wrong about this, please correct me, but I can’t seem to find anything stating otherwise.
But before I begin delving into which mutual fund I think is the best choice, my research has led me to be wary of a couple of things having to do with mutual funds:
- Management fees (Thanks Barb Friedberg! Her 20-minute Investing Guide cleared this up for me.) I really want to keep this low, as in under .3%, or 3 cents per every $100 of invested funds.
- Initial investment amounts.
- Transfer fees and miscellaneous fees associated with mutual funds.
- Okay, and I’ll add that they can be a more risky investment. (They aren’t FDIC insured, but neither is a 401(k) contribution limits for that matter.)
Using USAA.com as a starting point, I noticed that management fees were pretty low on most of their funds (over all their fees are quite low). Using MaxFunds.com as a cross-reference to check credibility and analyze particular funds a bit more, some of their management fees were as low as .15% (especially on the bond funds) and as high as .79% (on a particular equity fund). As a member of USAA, some of their equity and taxable bond funds will waive the initial investment amount as long as I set up monthly auto-debits, which start as low as $50 a month. Using USAA’s historical graph, I was able to view the average growth over a 10-year period noticing that bond’s grew every year, but at a tamer rate of about 6%, and equity funds grew slightly more over the same period but seemed much more unpredictable from year to year.
A favorite among some personal finance bloggers are index funds, which is another mutual fund option. The S&P 500 and the Nasdaq-100 are two favorites when it comes to indexes, they basically are an average of the stock market; if the market is up, you make money, if the market as a whole tanks, your mutual fund tanks as well. I’m on the fence with this one, mainly because opening an index fund with USAA, my favored broker, would require an initial investment of at least $3,000.
Another option that is backed by mutual funds is a 457(b). It’s a plan that my district offers as a supplement to their 403(b) retirement plan. Basically, it works like a mutual fund but there are some maximum annual amounts, up to $15,500 per year with a special “catch-up” phase 3-years before retirement. The benefit is it is a tax-deferred fund and there isn’t an early withdrawal penalty. I don’t really see the benefit in signing up for this plan, at least not right now, if I already intend to invest in a mutual fund. Although perhaps the biggest benefit is the “tax-deferral.”
Ultimately, I will probably choose a moderate to aggressive mutual fund with USAA, one that doesn’t require a minimum initial investment.
Do you invest in mutual funds? What do you look for in a supplement wealth building account?
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- Consumerist.com – showcased a guest post and swamped my website!
- Fark.com – same guest post grabbed lots of attention this week.
- Yakezie.com – it’s a fantastic, supportive community of personal finance bloggers.
- FirstGenAmerican.com – another Yakezie blogger.
- TheSavedQuarter.com – another Yakezie blogger – be sure to check out her Saved Quarter Challenge!
12 Comments
Yes, I invest in mutual funds. I have a 403B, IRA (wife), Roth IRA and a brokerage account. I like index funds and use Vanguard and TIAA-CREF for mutual funds.
.-= krantcents´s last blog ..My 2011 New Year’s Resolutions =-.
Tax deferral is a really big benefit! In your case I would go with the 457 before an outside fund unless it has high fees.
Right now our investment priorities are:
Mandatory retirement 403(b) to the match (tax deferred)
529 (a little every month)
Rest of 403(b)
IRA
then we’d go to the 457 (we don’t)
only then would we invest non-tax advantaged funds
We have everything in index funds and exchange traded funds, not mutual funds. Have you looked into how Vanguard compares to USAA in terms of minimums and fees?
.-= Nicole´s last blog ..RBOC =-.
Here’s part 1 and part 3 of our “Adventures in Retirement Saving” describing the nitty gritty of our thought process:
https://nicoleandmaggie.wordpress.com/2010/07/19/retirement-saving-part-1/
https://nicoleandmaggie.wordpress.com/2010/07/27/retirement-saving-part-3/
.-= Nicole´s last blog ..RBOC =-.
@krantcents
Thanks for sharing the funds you invest in. I’m still investigating a couple on my own, but any info is greatly appreciated!
@Nicole
@Nicole – Thanks for breaking down your retirement funds. I haven’t looked into Vanguard, but thanks for mentioning that. I’ll also check out your retirement series!
I’m SO BAD at looking/tracking/optimizing my retirement savings. A very small part of me wants to stay in debt so that I can have an easy goal to work toward. There is an infinite amount of ways to invest money and I really don’t want to put the time and effort into doing it properly. For now, I’m doing some vanguard things.
I think 1/2 of my savings is in a total market index fund. Most people can’t figure out how to beat the market on a regular basis so I figured it’s a safe bet. Then I wonder if TD waterhouse is the best place to have it all and if I should research other places too. Oh, it just makes my head want to spin.
Little House,
Just to clarify a couple of things dealing with types of accounts and investment types.
Type of Accounts
ROTH IRAs (Not tax deferred, but no taxes on any investment income within the account. RMD rules don’t kick into play until the owner [and spouse if married] dies when it goes through the inheritance. Of course, for the RMD not to kick in if the owner dies but not the spouse, the spouse receives the account.
Tax Deferred Traditional IRA (Tax deductible, but taxed as ordinary income when withdrawn.)
Taxable Traditional IRA (Not tax deductible due to income limits, but the earnings are still taxed as ordinary income. This requires quite a bit more work to keep it straight as compared to the others)
IRAs have a $5,000/$6,000 contribution limit per year. This limit is for all contributions made into all IRAs per person. Therefore like if you have a Traditional IRA and a ROTH IRA, you put $3,000 into ROTH, and $2,000 into Traditional, that is the most you can put in for yourself unless you are at least 50 years of age by the end of the year, which then would be another $1,000 more you can put into IRAs.
Employer’s retirement accounts that’s taxed deferred such as 401(k) plan. These are with higher contribution limits, which currently is $16,500/$22,000 for the employee.
Why the 2 different amounts? If you are not 50 by the end of the year, you can only put in up to the smaller number, but if you are at least 50 by the end of the year, then you can contribute up to the higher limit. Of course, once you reach the age of 70.5 years, then the option to contribute into a retirement plan becomes very restrictive, but can still be done in some cases.
Ideally, you would like to invest as much as you can into the retirement plans to get the tax treatment, but as you pointed out, there are some hefty penalties you face if you don’t follow through with the rules (hence, be a good idea to look over the exceptions for the different types of accounts).
Now you know, there are going to be some things that comes up along the way, which no doubt, you will eventually need to dip into for those items you will need to pay for. As such, to avoid the penalties of withdrawing from retirement accounts and not having to borrow against a retirement account (I.e. a 401(k) plan), you setup a regular brokage account (What I call annually taxable investment account). This type of account does have things taxed annually such as interest, dividends, and proceeds on the sale of investments. As such, that is what make this type of account not as favorable. However, for some things such as for building up wealth to repair/replace long-term assets (why would you want to put money into some saving or bond account for a minimal of 5 years and earn very little from it?), you would want to have the money grow with the rate of inflation, which also has to counter attack the taxation that comes with that additional increase to the investment valuation. Hence if inflation is 5%, you may need to earn a minimal of 7.5% to off set the tax bite and still beat out the inflation on an after tax effect. This is the very type of subject matter where double and triple taxation as taught in Accounting really comes into play.
Now onto the type of investments. The retirement accounts has some restrictions as to what types of investments you can have in them and the fact those items in them has to be totally separate from all of your other money. Now you can do stocks, bonds, or money markets, you can do government or corporate with bonds, and a few other things with a brokerage account.
For me, I have the following:
401(k) plan via my employer (Heavily the most funded, but also performs the worst based on the history of the different types as a result of the 2% or so assumed mutual fund fees as the prospectus says it’s only 0.50% or 0.75% depending on the different mutual funds via the plan, but they trended as 2% laggards to their respective market benchmarks. Therefore, I’m assuming the other 1.25% to 1.50% is via the 12b fees that’s hidden, but considered as operational expenses as allowed by regulation.
As for mutual funds, outside of the 401(k) plan (as I have no choice in the matter other than not to contribute into it at all, but then lose out on the matching policy), I personally do NOT invest in mutual funds as I have no trust for them. Outside of the 2010 calendar year, my investments outside of the 401(k) plan has trended 1% higher than the market benchmarks. In the year of 2010 though, this same group of funds went up 30% higher than the market benchmarks. Now rather if that was by something I did or if it was just by luck, only time will tell.
If you don’t have a lot to work with, you may want to do index funds as they are at the lowest costs attempting to mimic the actual stock market indexes. Of course, given different mixes, it won’t be exact, but it should normally be close. As your funds grow and you learn more of the stock market, then you may start working you way out of the index funds looking at different stocks, which then as you progress, you may even get to the point of doing the stocks full time (If you have a such desire). However, two rules I use, do not allow transaction fees be more than 1% of the total money in the transaction and invest for the long-term, not the here and now, thus you have to look past all of the hype.
Regardless which way you go, you must do your homework and make the best educated choice you can with what you have to work with. That’s easier said than done, but if you learn Finance and Accounting, it will give you a pretty good jump start in doing the necessary research including knowing how to read the financial reports.
For me, I have setup 3 different accounts with Scottrade. They are as follows:
Annually Taxable Investment Account (Brokerage Account)
ROTH IRA for my wife
ROTH IRA for myself
As for the initial start up, it only take $500.00. It also cost only $7.00 per transaction. Yes, you can go to another site that has transaction fees as low as $4.00, but to get that, you have to be in a regular automatic buy rather that be weekly or monthly. For me, that would not work as some parts of the year, we do good to keep study while other parts of the year, we get plenty of cash to be able to invest. I only do something like 10 transactions per year in my annually taxable investment account and even less than that in either of the 2 ROTH IRAs.
Currently, the Annually Taxable Account only make up 5% of it’s total goal (though my total goal for it is way higher than what most people like to have for their fund as most people don’t take into account depreciation on long-term assets). Of course, have to start from somewhere. Last year, I did end up taking from it twice, so this year, I have to put back into it. However, I have a set order of where the cash goes that goes beyond necessary living expenses.
1) Contribute into the employer’s retirement plan up to the point it maxes out the matching policy.
2) Contribute up to the maximum into the ROTH IRAs to max out the Retirement Saver’s Credit
Unless I’m in such financial dire straits that I can’t do the first 2 above, these 2 rules are 2 that I follow through regardless. Once this is achieved, it then becomes a balancing act. You must look at the following:
How much debt, what type of debts, and what’s the “After Tax Basis Effective Annual Percentage Rate” on such debts. Yes, I know this is a mouthful, but it can very easily impact the order of paying down debt.
How much of an emergency fund do you need to build up? Yes, you not going to do it overnight or even within one year (unless you are one very lucky sole). As such, you need to strategize, but ideally, the Emergency Fund would have the following:
A) Up to 12 months worth of necessary cash flow demands (necessary living expenses and minimal debt payments)
B) Total Accumulated Depreciation on Long-Term Assets (I.e. If you bought a house for $121,000 with $100,000 of it for the land improvements as the other $21,000 is for the land itself, and it’s on a 40 year depreciation schedule for the land improvement portion of it, after 5 years, that will be $12,500 depreciated from the home if nothing was done to it. As such, it would be expected to have in the EF to have this $12,500 to cover for this portion of the home). That’s just one example, but do that for all of your long-term assets (those items lasting longer than 1 year), and add them all up to get a total amount for this portion of the EF.
C) Sudden Losses. What if your home was suddenly destroyed by some situation outside of your control. What if your vehicle was totalled and you had to get reliable transportation relatively quickly. To make matters worse, what if the insurance company didn’t follow through and refused to give you a rental even though they are required to otherwise? Yes, we been in that kind of situation such as the time when my wife was involved in a 2 part accident involving our mini van, 3 tractor trailer semis and 1 tanker on I71 in Grant County of KY. The insarnce company of the one tractor trailer driver fought and fought and fought and refused us the rental as it was that driver’s fault for totaling our mini-van.
Yes, we had a lot to be thankful for such as it was a good thing the rig it it the way it did more or less spining it out of the main part of the wreck, else my entire family except for myself could have possibly been dead as they were all in the van with my wife being pregnant at that time while I was at work. It was also a good think the tanker was empty compared to what it could have been. However, this is just the kind of situation we had to have things in place to get back on our feet relatively quickly.
As this personal experience shows, it’s why I include the sudden loss as part of the EF along with 12 months of NECESSARY cash flow demands, and the value of the total accumulated depreciation on all long-term assets.
The trick to it all, you have to have a some sort of a balance act among the 3 routes to take (Retirement Funding, Debt Reduction, and EF), and how you going to split it out in the 3 different routes. As such, after the initial first 2 rules, I have to look to the family situation and see which way to go from there. There’s still a lot of numbers involved, but it’s also taking into account of our situation. Each household may have different issues to consider, thus there is no one right answer.
As I pointed out in earlier posts, that’s why I put the 25% of actual gross income go to savings apply to all 3 categories while also taking into account of residual income/(expenses).
I do use Excel extensively to help keep all of these different things straight and to help with the decision process.
Ideally for retirement funding purposes, I would do the following:
Max out Employer’s Matching Policy (Why leave free money on the table unless the fees on the account will more or less wipe out the benefits of the matching policy, which in most cases won’t be the case.)
Max out IRS’s Retirement Saver’s Credit via the ROTH IRA contributions (Another way to reduce your taxes, which you have until the tax due date to file for this purpose)
Max out ROTH IRA contributions as allowed by law (Put the money to where it’s going to work the most for you with this highest basis possible for that money as $5,000 after tax based is worth more than $5,000 before tax based is worth.)
Max out Employer’s contributions. (Up to amount allowed as there are other income limitations within the IRS rules, get as much of a tax benefit as you can.)
That’s just from a tax stand point of view primarily. Of course, you have to way your retirement savings to your EF savings and debt reduction goals.
@Ronald R. Dodge – I like the idea of maxing out my 403(b) – however my employer won’t match it. They are already matching a pension plan. I’ve researched Roth IRA’s and I don’t qualify since I don’t file jointly with my husband, however I think I qualify for the traditional IRA (something I need to look into.) I like the idea of putting more money into the tax saving options, like the 457(b). Thanks for sharing your strategies!
@Barb – Good point about the availability of the money. I’m thinking long term (like 15-20 years) so mutual funds might be a good option in this case. I’m still researching all of my options!
Little House,
I love these insights into people’s choices. You are basically deciding between increasing your non-qualified investments rather than your qualified accounts (your 403(b), 457, etc). Remember a mutual fund is just an investment within one of those types of accounts.
I am not sure if you went though it, remember that your non-qualified mutual funds WILL produce taxes so you’ll need to set aside cash for it come end of 2011/beginning of 2012
.-= Evan´s last blog ..The Past Wasn’t As Good As You Remember it So Get Over It =-.
@Evan – Thanks for pointing that out. That’s probably the most confusing aspect – that my qualified investments are still investments in mutual funds! I’m leaning more toward investing in the tax deferred options, then I don’t need to worry about planning ahead for taxes.