Analyzing The Best Retirement Plans And Investment Options: Introduction Knowledge is power, and this certainly holds true for retirement planning: the process of determining income and lifestyle goals and the actions you must take to achieve those goals. While retirement planning involves much more than finances - things such as when you will retire, where you will live, and what you will do - most of these factors depend largely on the income you can expect during your retirement years. The more you learn about and understand the various investment options, the better equipped you may be to make effective decisions. Because of the power of compounding, the earlier you start saving for retirement - through stocks, employer-sponsored plans, mutual funds or a large variety of other investments - the longer your money can work for you, and the more money you might be able to save for the future. In general, younger people are able to take on more risk: they have more years to recover from any losses. Older people, on the other hand, tend to be more conservative in their investments. This can be a bit of a Catch-22: since older investors tend to limit risk, the investments frequently have lower earnings potential. Starting early is one of the best ways to ensure you will have enough money to live comfortably during retirement. That said, it is "never too late" to start saving for retirement, and every little bit helps. The investments you choose for retirement may change over time in response to your goals, risk tolerance and investment horizon. Asset allocation - or how you apportion the various investments in your portfolio - is viewed by many as more important than the actual securities chosen for the portfolio. The three main asset classes include stocks (equities), bonds (fixed income), and cash and cash equivalents, and each has different levels of risk and return. Finding the balance that is most appropriate for your situation takes time and effort. Here, we provide an introduction to popular investments that may be considered when planning for retirement. Analyzing The Best Retirement Plans And Investment Options: Annuities • What they are: Insurance products that provide a source of monthly, quarterly, annual or lump sum income during retirement. • Pros: Tax-deferred growth of earnings; no annual contribution limit; steady income source during retirement. • Cons: Notoriously high expenses; surrender charges; early withdrawal penalties; payments may be taxed as ordinary income; no additional death benefit. • How to invest: Directly through insurance companies or through your broker. Annuity Basics An annuity is a contract between you and an insurance company that agrees to make periodic payments for a given period of time, or until a specified event occurs (for example, the death of the person who receives the payments). Whereas life insurance pays a benefit if an insured person dies, an annuity may make payments as long as an insured person lives. In this manner, annuities are often used to provide an income stream during retirement. You can "fund" an annuity all at once - known as a single premium - or you can pay over time. With an immediate annuity (also called an income annuity), fixed payments begin as soon as the investment is made. If you invest in a deferredannuity, the principal you invest grows for a specific period of time until you begin taking withdrawals - typically during retirement. The owner of the contract is the person who purchases the annuity and who is entitled to make changes to the policy; the annuitant is the insured person; and the beneficiary is the person designated by the owner to receive whatever is left in the annuity after the annuitant dies. In many cases, the owner and the annuitant are the same person, and the beneficiary is a spouse or child. In other cases, the owner and the annuitant may be different people. The annuitant becomes significant if and when the contract is annuitized. When a contract becomes annuitized, the annuitant receives a fixed monthly income from the insurance company (typically for life), while giving up any claim to receive a "lump sum" payment. The monthly income will be determined by the annuitant’s - and not the owner’s - age and life expectancy. For example, if a 40 year old woman purchases an annuity and designates her 70 year old father as the annuitant, he would qualify for larger monthly payments each month than his daughter would (because the insurance company would expect to make fewer payments to an older person). Types of Annuities There are three broad categories of annuities: Fixed With fixed annuities, the insurance company pays a guaranteed (or fixed) rate of interest while the account is growing. Fixed contracts are similar in function to certificates of deposit (CDs). Fixed annuities can be life annuities or term certain annuities. Life annuities pay a set amount each period until the annuitant passes away. Term certain annuities, on the other hand, pay a set amount per period for a fixed term. Once the term has elapsed, the annuity is spent (even if the annuitant is still living). Indexed With indexed annuities, the insurance company agrees to grow your investment by a specified annual interest rate or by a percentage of a particular index’s growth, such as the S&P 500 Composite Stock Price Index - whichever is greater. The indexed annuity’s participation rate determines how much gain in the index will be credited to the annuity. If there is 10% growth in the index, for example, and the participation rate is 80%, the annuity would be credited with 8% (80% of the 10% index growth). Indexed annuities may also be bound by a cap rate - a limit to the amount of growth that can be credited in any given year. If a 7% cap rate were in effect for the previous example, for instance, the annuity would be credited only 7% instead of the 8% (less any fees). Variable Variable annuities allow you to invest in a variety of pooled investment accounts, called subaccounts,within a variable annuity. These products are frequently referred to as "mutual funds with an insurance wrapper." Investments range from very conservative (for example, a money-market subaccount) to very aggressive (such as an aggressive growth stock fund subaccount). You decide how to allocate the funds. For example, if the insurance company offers two bond funds, a money market fund, and two stock funds, you could allocate 20% of the total contribution to each fund. Conversely, you could put the entire contribution into one subaccount; it is up to you. With variable annuities, the account value fluctuates in response to the markets and the particular subaccounts chosen. Variable annuities are considered securities, and are regulated by the Securities and Exchange Commission (SEC). Note: Annuities are complicated products, and the advantages, disadvantages and tax treatments differ significantly between products. It is recommended that anyone interested in an annuity for retirement planning consult with a qualified professional prior to making any decisions. Analyzing The Best Retirement Plans And Investment Options: Bonds • What they are: Debt securities in which you lend money to an issuer (such as a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value. • Pros: Certain bonds are risk-free (many are low-risk); predictable income; better returns compared with other short-term investments; certain bonds are tax exempt. • Cons: Potential for default; selling before maturity can result in a loss. • How to invest: Over-the-counter (OTC) markets including securities firms, banks, brokers and dealers. Some corporate bonds are listed on the New York Stock Exchange. U.S. government bonds can be purchased through a program called Treasury Direct (treasurydirect.gov). Bond Basics A bond is an IOU issued by a corporation or government in order to finance projects or activities. When you buy a bond, you are extending a loan to the bond issuer for a particular period of time. In exchange for the loan, the issuer agrees to pay you a specified interest rate (the coupon rate) at regular intervals until the bond matures. In general, the higher the interest rate, the higher the risk for a bond. When the bond matures, the issuer repays the loan and you receive the full face value (orpar value) of the bond. As an example, assume you buy a bond that has a face value of $1,000, a coupon of 5%, and a maturity of 10 years. You will receive a total of $50 of interest each year for the next 10 years ($1,000 * 5%). When the bond matures in 10 years, you will be paid the bond’s face value; or $1,000 in this example. As an alternative, you could sell the bond to another investor before the bond matures. If interest rates are more favorable now than when you bought the bond, you may take a loss and have to sell at a discount. If interest rates are lower, however, you may be able to sell the bond at a premium (since your higher-interest bond is more attractive). The price for the bond in the previous example (with a face value of $1,000, a 5% coupon, and a 10-year maturity) would decrease if bond rates rose to 6% or increase if bond rates fell to 4%. You would still, however, earn the 5% coupon and receive full face value if you decided to hold onto the bond until it matures. Bond Risk Bonds expose investors to several types of risk, including default, prepayment and interest rate risk. Default Risk The possibility that a bond issuer will not be able to make interest or principal payments when they are due is known as default risk. While many are considered no- or low-risk (such as short-term U.S. government debt securities), certain bonds, including corporate bonds, are subject to varying degrees of default risk. Bond rating agencies, including Fitch, Moody’s and Standard & Poor’s, publish evaluations of the credit quality and default risk for many corporate bonds. Prepayment Risk The possibility that a bond issue will be paid off earlier than expected is known as prepayment risk. This often occurs through a call provision. Many firms embed a call feature that allows them to redeem, or call, the bond before its maturity date at a specified call price. This feature provides flexibility to retire the bond early if, for example, interest rates decline. In general, the higher a bond’s interest rate in relation to current rates, the greater the risk of prepayment. If prepayment occurs, the principal is returned early and any remaining future interest payments will not be made. As a result, investors may be forced to reinvest funds in lower-interest rate bonds. Interest Rate Risk Interest rate risk is the possibility that interest rates will be different than expected. If interest rates decline significantly, you face the possibility of prepayment as firms exercise call features. If interest rates rise, you risk holding a bond with below-market rates. The longer the time to maturity, the higher the interest rate risk since it is difficult to predict rates farther into the future. Analyzing The Best Retirement Plans And Investment Options: Cash Investments • What they are: Low-risk, short-term obligations that provide returns in the form of interest payments. • Pros: Low- to no-risk; easily redeemable; often FDIC insured. • Cons: Withdrawal penalties may apply; low return. • How to invest: Directly through financial institutions; your broker; your local bank or credit union. Cash investments are easily redeemable, low-risk places to park your cash. Since the money is easy to get to, you can earn a small return while keeping cash available in case of emergencies. Cash investments include CDs, guaranteed investment contracts (GICs), money market deposit accounts, money market funds and savings accounts. Any earnings on these investments are inherently low due to their no-risk nature. Certificates of Deposit (CDs) A CD is a type of savings instrument issued by a bank, credit union or broker. They pay a specified rate of interest over a defined period of time, and repay your principal at maturity. If you cash in or redeem your CD before maturity, you may have to pay an early withdrawal penalty. CDs can be issued in any denomination, and maturities typically range from one month to five years or longer. They are FDIC-insured if they are issued by an FDIC-insured bank. If you buy a CD from your broker, the money should be put in a CD account at an FDIC-insured bank. If not, your CD will not be insured by the FDIC. Guaranteed Investment Contracts (GICs) GICs are insurance contracts that guarantee the owner a fixed or floating interest rate for a set period of time, plus the repayment of the principal. GICs essentially work like giant CDs but without FDIC insurance. Typically, GIC contracts run from one to seven years. These contracts are a popular investment options for 401(k) plans. Money Market Deposit Accounts (MMDAs) Money market deposit accounts are a type of savings account that offer a more competitive rate of interest in exchange for larger-than-normal deposits. MMDAs typically have restrictions that limit the number of transactions you can make each month and set a minimum balance in order to receive the more favorable interest rate. Funds in MMDAs are FDIC insured. Money Market Funds Money market funds are a type of mutual fund that deal in debt obligations. Unlike money market deposit accounts, money market funds are not federally insured. Money market funds may invest in: 1. U.S. Treasury funds 2. U.S. Government funds 3. General purpose corporate funds 4. Tax-free money market funds that invest in municipal bonds Savings Accounts Savings accounts are deposit accounts held at a bank or other financial institution, providing principal security and a modest interest rate. Although savings accounts pay lower interest rates than CDs, they typically offer better rates than checking accounts. There may be restrictions on the number of transactions that can be made each month. Analyzing The Best Retirement Plans And Investment Options: Direct Reinvestment Plans (DRIPS) • What they are: Plans offered by corporations that allow you to reinvest cash dividends by purchasing additional shares or factional shares on the dividend payment date. • Pros: Convenient means of reinvesting; often commission-free; shares may be purchased at a discount. • Cons: You owe taxes on cash dividends even though you never receive the cash. • How to invest: Directly through a participating company or its transfer agent. DRIP Basics A dividend reinvestment plan, or DRIP, is a plan offered by a company that allows you to automatically reinvest any cash dividends by purchasing additional shares or fractional shares on the dividend payment date. Instead of receiving your quarterly dividend check, the entity managing the DRIP (which could be the company, a transfer agent or a brokerage firm) puts the money, on your behalf, directly towards the purchase of additional shares. Many DRIPs allow you to start with a very small number of shares or low dollar amount (as little as one share or perhaps $10) and support fractional shares. For many investors, DRIPs offer a convenient method of reinvesting, and they are ideal for investors who do not need cash flow from dividends and who want to build their investment over the long term. Many DRIPs allow you to purchase the additional shares commission-free and even at a discount from the current share price. DRIPs that are operated by the company itself, for example, are commission-free since no broker is involved. Certain DRIPs extend the offer to shareholders to purchase additional shares in cash, directly from the company, at a discount ranging between 1 and 10%. Because of the discount and commission-free structure, the cost basis of shares acquired can be significantly lower than if bought outside of a DRIP. It is possible to create synthetic DRIPs through your brokerage account. Certain brokers, including Fidelity, Schwab and TD Ameritrade, offer to reinvest any dividends at no additional cost (outside of regular commissions). This can be an advantage if you want to reinvest your dividends from a company that does not offer a dividend reinvestment plan. Currently, about 1,300 companies offer DRIPs. Taxes With DRIPs, the primary disadvantage to shareholders is that they must pay taxes on the cash dividends reinvested in the company even though they never receive any cash. This holds true whether your dividends are reinvested directly through the company or if you set up a synthetic DRIP with a broker. Another concern with DRIP investing is that it often turns out to be a bit of a set-it-and-forget-it strategy. While this can be a good thing, it is not necessarily so if dividends have been slashed and share prices have dropped. As with any investment, it is important to periodically review and assess the performance of a DRIP to ensure it is meeting your investing goals. If you sell your shares that are held in a DRIP, you must calculate your cost basis: the purchase price plus any commissions and fees, taking into account any stock splits and other adjustments. Determining the cost basis for shares that have been held for a number of years with dividend reinvestment can be tricky; however, new laws require that this information be furnished to investors by brokers that offer DRIPs (this does not apply to investments you purchased before the laws went into effect on January 1, 2012). Analyzing The Best Retirement Plans And Investment Options: 401(k)s And Company Plans • What they are: Employer-sponsored plans, including 401(k)s and 403(b)s, that provide employees with automatic savings, tax incentives and (in some cases) matching contributions. • Pros: Contributions may be tax deductible; tax-deferred growth; matching contributions; possible to borrow from plan; possible to use funds for "hardship" withdrawals (e.g. to purchase your first home or to pay for the kids’ college). • Cons: Early withdrawal penalties; annual limits on contributions • How to invest: Connect with your employer’s Human Resources (HR) or Human Capital department. Plan Basics 401(k)s and other company plans are known as defined-contribution plans. This is because you - as an employee - contribute to the plan, typically through a payroll deduction each pay period. You decide what percentage of your salary will be contributed, and the deduction is automatically taken out of each paycheck. In some cases, your employer may also contribute to the plan in the form of a matching contribution. For example, your employer may contribute 25 cents for each dollar that you contribute, up to a maximum percentage of your salary (such as 3 to 5%). Though the contribution is known, the benefit - how much money you will get at retirement - is unknown. The types of plans offered by employers depend upon the company’s structure, and include: • 401(k)s - offered to corporate employees • 403(b)s - for employees of public education and most nonprofits • 457s - for state and municipal employees and certain nonprofits • Thrift Savings Plans (TSPs) - for federal employees Contribution Limits The Internal Revenue Service (IRS) sets limits for contributions. The limits are periodically adjusted upward in response to increases in the cost-of-living index. For tax year 2013, you can contribute up to $17,500 to a 401(k), 403(b), TSPs, and most 457s. In addition to normal contributions, employees who are age 50 and over can make a catch-up contribution of $5,500 to any of these plans. Investments Even though you and your employer contribute to your plan, you get to decide how the money is invested. The plans typically allow you to choose from a variety of investment choices, such as mutual funds, stocks (including your company’s stock), bonds and guaranteed investment contracts (GICs; similar to certificates of deposit). If you do not like the investment options offered by your employer, you may be able to transfer a percentage of your plan into another retirement account. This is known as a partial rollover. It is important to consider your risk tolerance and investment time horizon (how long you have until retirement), and to make careful decisions. In general, people are advised to invest more aggressively when they are younger (and are able to recover from losses) and to make more conservative investments as they approach retirement. As such, you may change your allocations over time. Most plans allow you to make changes whenever you want, while other permit changes only once a month or once per quarter. Vesting Any money that you contribute is yours; however, your company’s matching contributions will not be 100% yours until you are fully vested. Typically, these funds vest over time; for example, after the first year of employment you may be 25% vested, after the second year 50% vested, and so forth. After you are fully vested, all the money in the plan (your contributions plus your employer’s) is yours and you can take it with you if you change jobs or retire. Distributions In general, if you make a withdrawal before you are age 59.5, you will have to pay a 10% penalty tax on the distribution. You will not have to pay the penalty, however, if: • You suffer a disability • You have died and the distribution is made to a beneficiary • You have certain medical expenses • You buy your first home • You need funds to pay for college (for you, your spouse or your children) • You need money to avoid foreclosure or eviction • You need money for burial or funeral expenses • You need money to pay for certain repairs to your home After you turn 70.5, you will have to make required minimum distributions (RMDs). In general, you have to start withdrawing money by April 1 of the year following the year that you turn 70.5. Your age (and life expectancy) and account value determine the required minimum distribution. Analyzing The Best Retirement Plans And Investment Options: Exchange Traded Funds (ETFs) • What they are: Uniquely structured investment funds that track broad-based or sector indexes, commodities and baskets of assets. • Pros: Trade like stocks on regulated exchanges; diversity in a single investment; low expense ratios; tax efficient; some trade commission-free through participating brokers. • Cons: Certain ETFs subject to contango; bid-ask spreads can be large; certain ETFs are taxed at a higher rate (such as gains on ETFs that hold physical precious metals). • How to invest: ETFs trade just like stocks on regulated exchanges. You can trade online using your broker’s online trading platform, or by calling your broker’s trade desk to place orders. ETF Basics Exchange traded funds, or ETFs, are uniquely structured investment funds that track broad-based or sector indexes, commodities and baskets of assets. With access to nearly any asset class or sector, ETFs offer exposure to markets that have traditionally been challenging for individual investors to tap into, such as commodities and emerging markets. Since the first exchange traded fund was introduced in 1993, ETFs have become increasingly popular because they: • Are tax efficient investments • Boast low expense ratios • Can be sold short and purchased on margin • Maintain inherent liquidity • Offer diversity in a single investment • Provide intraday trading access • Trade just like stocks on regulated exchanges ETF Structure Exchanged-traded funds and exchange-traded products (ETPs) use different product structures. When investing in an ETF, it is important to understand the fund’s legal structure and corresponding implications, including financial risks and tax treatment. This information is generally available in the fund’s prospectus. It should be noted that the term "ETF" is frequently used as a catchall for both ETFs and other exchange-traded products. ETNs, for example, are not actually ETFs but are similarly categorized. There are five types of structures for exchange-traded products, including ETFs: open-end fund, unit investment trusts, grantor trusts, limited partnerships and exchange-traded notes. Open-End Funds Most ETFs use an open-end structure. These funds must be registered with the Securities and Exchange Commission under its Investment Company Act of 1940, and there are no restrictions on the number of shares that the fund can issue. As long as there is demand, the fund can continue to issue shares. Any dividends are reinvested on the day of receipt and cash distributions are paid to shareholders each quarter. Unit Investment Trusts (UITs) The other primary ETF structure is a unit investment trust, or "UIT.” Also regulated by the SEC Investment Company Act of 1940, UITs are required to fully replicate their specific indexes while restricting investments in a single issue to 25% or less. A UIT holds its investments with little or no change for its duration. A UIT makes a "public offering" of a fixed number of units that are tradable on a secondary market. When a UIT is created, an expiration date is established; when the UIT terminates, any remaining securities are sold and any proceeds are paid to investors. Dividends are held until they are paid to shareholders, generally on a quarterly basis. Grantor Trusts Grantor trust investment portfolios are fixed and cannot be changed at a later date. Dividends are immediately distributed to shareholders, and investors have the same voting rights as any other shareholder for each company in the trust’s portfolio. Grantor trusts can be tax efficient and investors can control taxes by deciding when to sell their shares. Many grantor trusts hold physical assets and own single commodities, such as the SPDR Gold Shares ETF (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV), while others invest in a portfolio of securities. Dividends are immediately distributed to shareholders. Limited Partnerships (LPs) A limited partnership, or an "LP,” is an alternative legal structure that is not an Investment Company within the meaning of the SEC Investment Company Act of 1940. The most well-known limited partnerships are the United States Oil Fund (NYSE: USO) and the United States Natural Gas Fund (NYSEArca: UNG). These funds, which invest through futures contracts, are taxed each year even if you still own the position; capital gains are taxed at the hybrid 60% long-term and 40% short-term rates. Dividends may or may not be reinvested. Exchange-Traded Notes (ETNs) Exchange-traded notes, or "ETNs,” are unsecured debt securities that pay a return linked to the performance of an individual commodity, currency or index. ETNs have a specified date of maturity that can be as long as 30 years or more. These investment products are subject to counterparty risk: the creditworthiness of the backing institution can negatively impact the ETN’s value, even if the underlying index performs well. Typically, ETNs do not pay dividends or annual coupons. Analyzing The Best Retirement Plans And Investment Options: Individual Retirement Accounts (IRAs) • What they are: An individual savings account with tax incentives. • Pros: Tax benefits - investments grow tax-deferred and contributions may be deductible; variety of investment options with wide range of risk/reward characteristics. • Cons: Early withdrawal penalties plus you may have to pay income tax on the amount; limits on annual contributions; eligibility restrictions. • How to invest: Directly through financial institutions including banks, mutual fund companies and brokerage firms. IRA Basics An IRA can be thought of as a savings account that has tax benefits. You open an IRA for yourself - that is why it is called an individual retirement account. If you have a spouse, you will each have a separate IRA. An important distinction to make is that an IRA is not an investment itself; rather, it is an account where you keep investments such as stocks, bonds and mutual funds. You get to choose the investments in the account, and can change the investments if you wish. There are several types of IRAs, including traditional, Roth, SEP and SIMPLE. In many cases, you can have more than one type of IRA as long as you meet certain requirements. Traditional and Roth IRAs The primary difference between traditional and Roth IRAs is when you pay taxes on the money that you contribute to the plan. With a traditional IRA, you pay taxes when you withdraw the money during retirement. With a Roth IRA, you pay taxes when you put the money into the account. The money grows tax free while it’s in either a traditional or Roth IRA. Another difference between traditional and Roth IRAs is who can contribute. With traditional IRAs, almost anyone with earned income can contribute. With Roth IRAs, however, your income may prevent you from contributing. Ordinarily, you are able to contribute to a Roth IRA if your modified adjusted gross income is (current for tax year 2013): • Less than $188,000 if you are married, filing jointly • Less than $127,000 if you are single, head of household, or married, filing separately (and did not live with your spouse during the previous year) • Less than $10,000 if you are married, filing separately and you lived with your spouse at any point during the previous year For 2013, you can contribute the smaller of $5,500 or your taxable compensation for the year to traditional or Roth IRAs. SEP and SIMPLE IRAs Simplified Employee Pension IRAs, or SEP IRAs, are a type of traditional IRA for self-employed individuals and small business owners. You can open a SEP IRA if you are a business owner with one or more employees, or if you are an individual with freelance income. All employees must be included in the SEP if they are at least 21 years old, have worked for your business for three out of the previous five years, and if they have received at least $550 in compensation from your business. Contributions are tax deductible (for the business or individual) and go into a traditional IRA in the employee’s name, and employees are fully vested at all times. For 2013, contributions cannot exceed the lesser of 25% of the employee’s compensation or $51,000. Catch-up contributions are not permitted. A SIMPLE IRA (Savings Incentive match Plan for Employees) is an IRA set up by a small employer for its employees. Unlike a SEP IRA, employees are allowed to contribute to SIMPLE IRAs. Eligible and participating employees can make salary reduction contributions up to a certain amount; for 2013, the employee can "defer" up to $12,000. In turn, the employer must make either a matching contribution up to 3% of your salary, or a nonelective contribution of 2% of your compensation. Required Minimum Distributions Individual retirement accounts, including traditional, Roth, SEP and SIMPLE IRAs, are subject torequired minimum distributions (RMDs). In general, you must make withdrawals before April 1 of the year following the year you turn 70.5. For all subsequent years, you must take the RMD before December 31 of each year. How much you are required to take depends on the account balance and your age. In general, the RMD is calculated by dividing the prior end-of-year balance by a life expectancy factor that is published in Tables in IRS Publication 590, Individual Retirement Arrangements. You will use a different table depending on your situation; for example, you would use the Joint and Last Survivor Table if your sole beneficiary of the account is your spouse, and he or she is more than 10 years younger than you are. Analyzing The Best Retirement Plans And Investment Options: Mutual Funds • What they are: A professionally managed pool of stocks, bonds and/or other instruments that is divided into shares and sold to investors. • Pros: Diversification; liquidity; simplicity; affordability (low initial purchases); professionally managed. • Cons: Fluctuating returns; over-diversification; taxes; high costs; professional management doesn’t guarantee good performance. • How to invest: Directly through mutual fund companies; discount and full service brokerage firms; banks; insurance agents. Mutual Fund Basics A mutual fund is a company that pools money from many different investors to invest in a set portfolio of stocks, bonds and other securities. The fund’s professional money manager (or team of managers) researches, selects and monitors the performance of the fund’s portfolio. Each investor owns shares of the fund, which represent a portion of the fund’s holdings. The price that you pay for a mutual fund is the fund’s per share net asset value (NAV) plus any shareholder fees imposed by the fund. Most funds calculate their NAV at least once each business day, usually after the close of the major U.S. exchanges. Because mutual fund shares are redeemable, you can sell your shares back to the fund (or to a broker acting on behalf of the fund) on any business day. There are three ways in which you can make money from mutual funds: 1. Dividend payments. If the fund earns income in the form of dividends and interest on its portfolio’s securities, the fund will pay its shareholders close to all of the income it has earned, less disclosed expenses. 2. Capital gains distributions. If a fund sells a security that has increased in price, the fund will distribute the capital gains, less any capital losses, to investors at the end of the year. 3. Increased NAV. A higher NAV represents an increased value for your mutual fund investment. Typically, you can decide if you want to receive dividend payments and capital gains distributions, or if you want the money reinvested in the fund to purchase additional shares. Open-End Vs. Closed-End Funds Most mutual funds are open-end funds. Open-end funds have no limits regarding the number of shares that the fund can issue and sell. As a result, the growth potential of the fund, in terms of investment dollars, is open-ended (and not limited). Even though there are no limits, a fund managercan decide to close the fund to new investors if the fund would become too large to effectively manage. Closed-end funds, on the other hand, establish at the outset the number of shares that will be available for sale to the public. After the shares have been sold through an initial public offering(IPO), the fund is closed. New investors can buy into the fund only if there is a willing seller. Types of Funds Most mutual funds are money market funds, bond funds (or fixed income or income funds) or stock funds (also called equity funds). As with most investments, the higher the potential returns, the higher the risk. Money market funds Money market funds are considered lower risk than other types of mutual funds. By law, they are limited to investing in certain high-quality, short-term investments issued by the U.S. government (such as Treasury bills), U.S. corporations, and state and municipal governments. Returns tend to be twice what you would expect to earn in a savings account, and a bit less than a certificate of deposit (CD). These funds attempt to maintain a NAV at a stable $1 per share, and the fund pays dividends that generally reflect short-term interest rates. Bond funds Bond funds have higher risk than money market funds, in part because they seek higher returns. Because there are many different types of bonds, and these funds are not restricted to high-quality, short-term investments (like money market funds are), the funds vary greatly in terms of risks and rewards. Bond funds are exposed to the same risks associated with bonds: credit/default risk, prepayment risk and interest rate risk (discussed in the Bonds section of this tutorial). Stock funds Funds that invest in stocks make up the largest category of mutual funds. Stock funds, or equity funds, utilize various strategies. Growth funds, for example, focus on stocks that have the potential for large capital gains. Income funds, on the other hand, invest in stocks that pay regular dividends. Stock funds are exposed to the same market risk as individual stocks, and prices can fluctuate - at times dramatically - due to a variety of factors, including the overall strength of the economy. Target Date Funds Target date funds are structured to adjust allocations based on a target retirement date. From an investor’s standpoint, they offer an easy way to manage investments based on the number of years they have left until retirement. Investors make one decision: select the target date fund that most closely matches the year they expect to retire. For example, if it is 2013 and you expect to retire in 17 years, you might select a target date fund of 2030 or 2035. As a target fund approaches its target date, it automatically shifts to more conservative investments by moving assets from higher-risk instruments such as equities into low risk holdings such as fixed-income securities. It is important to remember, however, that these funds hold the same risks as other mutual funds; they do not guarantee any type of income stream for retirement.
Posted on: Mon, 08 Jul 2013 09:38:02 +0000
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