Tag: retirement

What are these things called Mutual Funds, really?

           When it comes to investing, so many people hear, “You should invest in mutual funds.” And with out question, most people do. So many people invest in mutual funds that, today, nearly half of American households own mutual funds. This number is staggering considering that the number of households owning mutual funds was 6% in 1980. The increase is due to the increased availability and participation in retirement accounts, where mutual funds are the primary, and usually only, investment option.

            With so many individuals investing in mutual funds, it should be surprising that very few mutual fund owners actually know how they work.  But it isn’t, because the working of mutual funds are clear as mud. Over the next few blog posts, I hope to unmuddy the waters.

What is a mutual fund?

Let’s begin with the definition of a mutual fund. Investor.gov defines mutual funds as “a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt.”  The type of security that the mutual fund invests in depends on the objective of the fund. (We will discuss fund types in another post.) Each mutual fund has a ticker symbol. A ticker symbol is a unique five letter abbreviation used to identify mutual funds on the stock market. When purchasing a mutual fund, it is common to use the fund’s ticker symbol instead of its proper name.

The value of a mutual fund is determined by the value of the stocks at the end each trading day minus the liabilities or the expenses of the fund including management fees, the cost of keeping the “lights” on, etc. This value is called the Net Asset Value commonly called, “NAV.” The NAV is the amount that is quoted for the price of the Mutual Fund.  Note that since NAV is calculated at the end of the trading day, it is the prior day’s information.

For a simple illustration of how mutual funds work, I created my own fictional mutual fund. Since I love to shop, I have created a fake retail mutual fund called, TheIvyInvestor’s Retail Fund (ticker: IIRVX). It has three stocks for simplicity; but note, most mutual funds have hundreds of stocks.

 IIRVX opened on February 7, 2013 with 1000 shares outstanding.

Stock Symbol Company Share Price (as of 2/7/2013) Number of shares Value
JWN Nordstrom $54.91 100 $5,491.00
KORS Michael Kors $56.66 100 $5,666.00
M Macy’s $54.91 100 $5,491.00
$16,648.00

As you can see, the average investor cannot afford to purchase 100 shares of these stocks, let alone this full portfolio, a group of holdings —i.e. stocks or bonds— in a mutual fund.  To get a piece of the “action,” you can buy a share of IIRVX for $22.23. This $22.23 will not purchase individual shares of Macy’s, Michael Kors, or Nordstrom directly; but it will allow you to participate in these companies’ growth by owning shares of the mutual fund which holds them.

 How was the share price of IIRVX calculated on February 7, 2013?

 The NAV is calculated:

$16,648.00 (value of the securities at the end of the trading day)

- $2,500(liabilities)

$14, 148.00

$14, 148.00/1000 IIRVX shareholders = $14.15 NAV.

 IIRVX’s value on  February 7, 2014 with 1100 shares outstanding.

Stock Symbol Company Share Price (as of 2/7/2014) Number of shares Value
JWN Nordstrom $58.79 100 $5,879.00
KORS Michael Kors $94.22 100 $9,422.00
M Macy’s $53.09 100 $5,309.00
$20,610.00

How was the share price of IIRVX calculated on February 7, 2014?

The NAV is calculated:

$20,610.00 (value of the securities at the end of the trading day)

- $2,500(liabilities)

$18,110.00

$18,110.00/1100 IIRVX shareholders = $16.46 NAV.

As you can see, NAV changes day-to-day depending on: (1) the prices of the stocks that the fund holds, and (2) the number of shareholders.

This week’s blog posts will be a series on mutual funds. The next few posts will cover:

1. How do you make money in a mutual fund and Tax consequences

2. An in-depth look into mutual fund fees

3. Types of mutual funds available

Demystifying the Alphabet soup of Retirement

Retirement. Everyone wants to get there but very few know how. When individuals receive their benefit package, it often contains information about how to enroll in a retirement plan, but not much else. There are a lot of retirement options - SSI, IRA, 401(k), 403(b), IRRA, Roth IRA - but what good are options if you don’t know how to use them? This blog post is part of an ongoing series about retirement. As a random fact, the names 401(k) and 403(b) come from the section of the Internal Revenue Code that allows them.

 Ideally, retirement assets should be compromised of savings and investments, social security benefits and if available, pension benefits (defined benefit plans). Unfortunately, the overwhelming majority of companies no longer provide pension benefits for employees. As a result, if an individual does not have a substantial amount of savings available for retirement, then they are forced to rely on social security as their sole source of income.  Often, social security benefits cannot cover day-to-day living expenses forcing many individuals to work longer or never fully retire.

But for those of us who have 20 to 30 years left until retirement, we have so many options available to us to save and secure our future. Let’s use them wisely.  There are two basic retirement options available - employer sponsored plans and individual retirement accounts.

Employer Sponsored Retirement Accounts (Defined contribution plans)

The type of business your employer has, in addition to the type of work it does, generally dictates the type of employer sponsored plan available. For instance, 401(k) plans are traditionally used by for profit, larger companies; 403(b) plans are used by non-profit organizations such as schools, hospitals, and churches; 457 and Thrift Savings plans are used by government agencies. Although most employer sponsored plans share similar qualities, there are some differences.

How much can I contribute? 

For 2014, the contribution limit is $17,500.00 for employees under the age of 50. Employees over the age of 50 are given the ability to accelerate their savings with a “catch up” provision and can contribute an additional $5,500.00. Traditionally, only before tax money was contributed to employer sponsored accounts. Now, some employers offer a “Roth” option in their plans, which allow contributions after tax money. However, Roth and Traditional contributions cannot exceed the allowable amount for the year. For example, if you are under 50, you can contribute $10,000.00 before taxes and $7,500.00 after taxes during the year. For information from the IRS, click here.

Employer Match?

In plans where the employer offers a match, those matching funds may not be yours immediately. Matching funds are usually set up on a graduated vesting schedule. Vesting basically is the time table for when your will be entitled to 100% of the money your employer has contributed on your behalf. The longer you work for the company, the more of the match is yours. Full vesting can take anywhere from five to seven years.  However, all of your contributions are immediately vested.

Individual Retirement Accounts (IRAs)

Individual retirement accounts (IRAs). Overall, there are two types of IRAs, a traditional IRA and a Roth IRA. IRAs are individual accounts that can be set up through financial institutions, such as a bank or brokerage firm (e.g. E Trade, Scotttrade, etc).  A traditional IRA allows you to contribute money before taxes; the money grows tax deferred, and you pay taxes on the money once you withdraw the funds in retirement. This is true as long as the contribution rules are followed. A Roth IRA allows you to contribute after tax money and have it grow tax free. No taxes are paid when you withdraw the money in retirement.

How much can I contribute? 

In 2014, the contribution limit for IRAs for individuals under 50 is $5,500. For those individuals over the age of 50, they are allowed an additional $1,000.00. For information from the IRS, click here.

There are also income limits to consider when dealing with IRAs. For a traditional IRA, if you have an employer sponsored plan at work, the amount of the contribution that the IRS will allow you to deduct will decrease as you make more money.  With Roth IRAs there are a few snags. For example, you cannot contribute more money to an IRA than what you earned in a given year. For individuals above a certain income (IRS website), the amount you are able to contribute can be reduced or completely eliminated.

What is the difference in contributions? (Roth v. Traditional)

With Traditional accounts, both IRA and employer sponsored, contributions before taxes, grow tax deferred, and are taxed when you withdraw. The benefit of making before tax contributions is the ability to lower your taxable income now.  If you make $80,000, and contribute $15,000, your taxable income is $65,000.  The drawback of not paying taxes now is that you will have to pay them later, and you have to hope that your tax bracket is lower than what it is now.

With Roth accounts, both IRA and employer sponsored, contributions are after taxes, grow tax free, and are not taxed when you withdraw.  The benefit of making after tax contributions is that you are able to position yourself in the future with a sum of money that is tax free.  The drawback of paying taxes now is, well just that, you are paying taxes now.

I suggest AT LEAST using your employer account to get the match, if available.  There are many calculators online to determine how much pre-tax contributions will it affect your take home. Use them. The best strategy is diversifying your taxes — contribute some pre-tax money and contribute some after tax money, either to a Roth IRA or a Roth employer sponsored plan.

Rollovers

Three words. JUST DO IT! There are a few things that can happen with old employer accounts.

One, the old account can sit around unmonitored. Unmonitored accounts are not a good idea. Employer plans can change investment options at any time. Sometimes the investments you thought you had can be phased out and your money sits around in a money market mutual fund doing nothing.

Two, you could be “forced out” of the employer’s plan because you don’t have enough money to stay in. Each plan and amount is different.  This force out could get you a check in your hand.  The money in your hand is now taxable at your ordinary income tax rate; and if you are under the age of 55, you could be charged with an additional 10% penalty. It’s not worth it.

Three, this is the best option. You can ROLL the money over to your new employer account, if able, OR (my personal favorite) ROLL the money into an IRA.  Why do I love rolling money into IRAs? It’s yours!

Investment Options

In a few weeks, I will discuss investing in more detail.