Mutual Fund Basics For Retirement Planning

What is a Mutual Fund?

For starters, understanding what a mutual fund is might be mind-boggling. Whether you’re nearing retirement, a seasoned executive, or a newly hired employee, there is no better time to educate yourself about mutual funds than now. Too many people pass on the idea of familiarizing themselves with various investment vehicles. They wake up years later only to realize how much time they have wasted for not doing so. In this blog I will help you understand key points about mutual funds and how they work to your advantage upon retirement.

To begin with, most of us rely on our 401(k) savings as the source of our retirement. Hopefully they will cover our future costs for healthcare, maintaining lifestyle, and items you might have on a bucket list. In an August 2015 survey by Charles Schwab:

  • 91% of those asked say their companies offer a 401(k) matching program,
  • 45% of the participants said that their 401(k) plan is their largest source of retirement savings,
  • 25% have taken a loan from their 401(k)
  • 67% of the respondents are seeking a personalized investment advice on their 401(k), and
  • Only 5% of the total number of persons surveyed is extremely confident in their ability to develop a retirement plan outside the scope of the 401(k).



It is true that a traditional 401(k) can help you save, but there are restrictions that come with it. There is a time period, or vesting, before employers begin payments to your 401(k) as their assurance against you leaving the company early. You also cannot oversee your account and this will only become possible through an administrator hired by your employer.

Most money experts suggest refraining from withdrawing your 401(k) savings before you reach 59 ½ years old. Often times you can’t gain access if you leave the company before 55 years old. While hardship withdrawals or loans against your 401(k) savings may be done and can indeed help you in the short-term, it will cause you to owe ordinary income taxes and interest rates in the long run. Technically, there is a 10% penalty on top of the usual tax bill depending on your location. Moreover, the potential for your savings to grow further diminishes. There are indeed expensive penalties that come with withdrawing your 401(k) savings before retirement age.

Having said these scenarios, a backup plan to ensure yourself a comfortable retirement is of utmost importance. Let us take a look at how mutual funds work.


How Does a Mutual Fund Work?

A sound retirement plan must include a portfolio of stocks, bonds and some cash. This is where a mutual fund as an investment vehicle for retirement can be useful. Along with other individual investors, your money is put together into one big investment that is handled by a money manager. He supervises a team of analysts who monitor how the pool of money is allocated to each individual investor’s portfolio. While a mutual fund refers to an investment program, it may also refer to a company that combines money from many investors and invests them in a wide range of securities. These securities (also known as holdings) include:

  1. Stocks– shares of a company
  2. Bonds– debt investments for raising capital
  3. Short-term money market instruments– treasury bills, asset-backed securities, certificates of deposit, etc.
  4. Cash
  5. Combination of the above-mentioned
  6. Even other mutual funds



A mutual fund is an “open-end company” where investors purchase shares from the fund itself, instead of other investors coming from secondary markets (NASDAQ, S&P 500, Dow Jones). They also accommodate investors with a limited budget such as those with as little as $1,000, for initial purchases. Mutual fund investors also benefit from their liquidity since their shares may be redeemed at any time at their net asset value (NAV). Also, a mutual fund manager monitors the performance of each security.  This makes this investment program ideal for anyone who doesn’t have the technical know-how on how various funds work. This is also where deciding which funds you wish your contributions to be invested in becomes a challenge.

When you’re not equipped with the right amount of knowledge, you will miss out on the opportunities to accelerate the growth of your investments. The money manager (or fund manager) doesn’t make the decisions on how you allocate your investment to the different securities. It is your responsibility to assess how to build your portfolio based on your risk appetite. Mutual fund holdings are also publicly available all over the internet for your monitoring.

One common term that typically goes with the discussion of mutual funds is diversification. In layman’s terms, it is simply the rule of “not putting your eggs in one basket”. When you buy a mutual fund, you gain instant access to hundreds of individual stocks and bonds. I will discuss later where they come from within and outside of the country.

Lets summarize. With mutual funds, you enjoy the benefits of affordability, fund diversification, sound money management by a professional, transparency, and liquidity.



A mutual fund is only one of three investment companies that provide investors like you with sound financial plans. The other two are “closed-end funds” and “unit investment trusts or UITs”.

There are different types of mutual funds.

  1. Bond Funds:

    These offer wide diversification for your hard-earned dollar from government and privately-held corporations. Bond funds are easier to sell versus individual funds. You can also easily reinvest payouts. The risks and returns change dramatically because the SEC does not limit bond to short- or long-term investments.


  1. Money Market Funds

    These can be ideal for older investors who look for safety rather than growth on their purchases. The reason is that the returns for money market funds are way lower compared to bond funds and more even so against stock funds. A common concern by most investors with money market funds is the inflation risk.


  1. Stock Funds

    These funds pose the highest market risk because their value rises or falls quickly in just a short time. Ideally, they grow over a long term. People in their 20’s or 30’s could enjoy high returns from their investments after giving it a 10 to 20 year waiting period.

These types of funds have pros and cons depending on your age and risk appetite. the best mutual fund approach to diversification should be one that involves stocks, bonds, and some cash. The basic rules are:

  1. Your fund should invest more in stocks when you’re younger.
  2. As you get older, a larger percentage of your investments should be focused on bonds.
  3. As you near retirement age, that’s the perfect time to use some cash in your portfolio.



Shareholder Fees

Most mutual fund companies charge annual shareholder fees amounting 0.5 to 2.5% of assets. There are also funds that give sales charges on top of the annual fees. Sales charges are a result of your putting in new money to the fund, or a cut from your withdrawals.

According to the Financial Industry Regulatory Authority (FINRA), front-end loads (or sales charges that go to brokers when you buy mutual fund shares), should not be higher than 8.5% of your investment. You may also be charged with a purchase fee that goes to the fund and not to the broker when you buy shares, while a broker will enjoy deferred sales charges through the same transaction as well. In return of maintaining your fund, you will be charged with an account fee. The fund may also receive a redemption fee every time you sell shares. When you transfer some of your funds to another within the same group, there are exchange fees.

Annual Operating Expenses

Your fund’s investment adviser and its associates may also charge you with management fees. This is in return for managing your investments. The expenses incurred for advertising, printing marketing materials and selling fund shares are charged to you and they fall under distribution and/or service fees. The expense ratio, or the total annual fund operating expenses, should not be more than 1%.



Investments have the unlimited capacity to grow further with time on your side. Thanks to the principle of compounding interest. But with fees attached that vary according to each mutual fund company, you will have to check on which among them will give you the highest rewards.

Here’s an example of two identical funds with different annual fees attached. Fund A charges 2.5% operating expenses, while Fund B takes only 0.25%. Let us assume an initial deposit of $15,000 plus additional contributions increased to 7% annually, then an 8% annual rate of return. We see in the chart below that Fund B gives your investments a higher yield in part due to their lower fees.


Lets Compare The Funds

The following illustrations give you a more detailed look on how your money grows on an annual basis when we apply the principle of compounding interest.

Fund A:

Assuming yearly savings contributions after initial deposit of $15,000 that increases at 7%, Fund A at 8% annual rate of return with 2.5% fees will give you a total cash value of $304,978 after 10 years. Total contributions amount to $207,248, and total fees amount to $38,080. This gives you total returns amounting to $59,650.


Fund B:

Fund B on the other hand, with only 0.25% annual fees, as shown in the illustration below, showed total costs on fees amounting to $4,049. Assuming no withdrawals were made, it gives you an ending balance by year 10 amounting to 60% of your total contributions, or $127,460.



Using the same figures again with Fund A charging 2.5% fees and Fund B with 0.25% fees. Let’s see what happens in a bear market scenario where unit prices of the fund suddenly drop by 4%, and then goes back up at 8% the following year. The graph below shows a significant difference on your growth horizon. Assuming a fixed 8% interest rate regardless of the fund, cash values on returns are much higher versus the said funds experiencing a drop on interest rates at year 4 alone.



The graph below, on the other hand, compares the annual ending balances of each fund at 8% fixed interest rate and when a bear market on year 4 occurs. Notice the long-term effect by the end of year 10.



Assuming a fixed interest rate at 8% on your premium contributions after 10 years, Fund A gives you a cash value of $304,978. Fund B shows an ending balance $338,775.

In a bear market scenario where interest rates drop at 4% on year 4, we see dramatic changes on the returns. After 10 years, Fund A will only give you $290,267 while Fund B $326,484.



With all these expenses charged to you depending on the mutual fund you decide to purchase, it is therefore important to make a well-calculated judgement on which funds will give you the lowest expenses but higher returns

To illustrate an example, let us take a look at the top 3 highest performing mutual funds as of September 2015. Let’s say you are investing the minimum initial purchase requirement of $15,000 and expecting an 8% return after 10 years. In this table obtained recently from the fund analyzer of the FINRA, one of the funds has the highest fees yet the lowest fund value after either 10 or 20 years.

Fund Name Ticker 1st Year Fees 5th Year Fees 10-Year Accumulated Fees Profit/ Loss after 10 years Fund Value After 10 years Fund Value after 20 years
ProFunds UltraShort Latin America Inv UFPIX $275.06 $1,553.49 $3,641.72 $12,103.83 $27,103.83 $48,974.51
ProFunds UltraShort Latin America Svc UFPSX $427.44 $2,363.71 $5,386.09 $9,524.66 $24,524.66 $40,097.28
ProFunds UltraShort Latin America Inv UHPIX $275.06 $1,553.49 $3,641.72 $12,103.83 $27,103.83 $48,974.51


At first glance, you may be overwhelmed by the fees that a fund requires on an annual basis. It is important to note of independent studies proving that one of the dependable factors affecting a fund’s performance is its expenses and fees.



As explained earlier, your time horizon and risk tolerance are the key factors when deciding on your asset allocation in order to diversify your investment portfolio. It is the most important decision of every investor because it will signify earnings or losses, and whether financial goals at a future period are achieved or not. Stocks, bonds and cash, as you know by now, are the most common categories for allocating assets in a fund.

Now here’s how pooled mutual funds are typically allocated:

  1. Balanced mutual funds are a simple choice for investors who want to own a good combination of both stocks and bonds in their portfolio, usually in the 50-50 or 60-40 mix.
  2. Target-date (or life cycle) mutual funds give investors the opportunity to automatically reset the mix of bonds, stocks and cash equivalents in the portfolio according to chosen time period.

It is therefore necessary that you understand your time horizon and risk tolerance first before you decide on how you diversify your portfolio. Reviewing both the risks and rewards of allocating funds accordingly may be challenging but is a good practice of a smart investor. Historically, stocks bring in the highest returns but may also pose the biggest risks. Bonds are less unpredictable but bring modest returns. Lastly, cash have the safest risks but the lowest returns as well.



Unlike in the past when the internet wasn’t available, all the information an investor needs about each mutual fund is readily available on many sources today, with updates provided on a daily basis. Data on which corporations or government institutions a mutual fund company owns are readily available to the public when requested. A comprehensive analysis on the portfolio of this company, for example, shows their asset distribution of US and non-US stocks, bonds, cash and others. Percentages of stocks and bonds invested to various industries are also featured, thereby giving investors first-hand information that the fund devotes a high number to stocks in the financial service and technology industries. We also see the breakdown of countries or geographic regions where these corporations and government institutions are located, with majority of them found in the United States.

If you seek to maximize your returns by diversifying your portfolio with the strongest global corporations in mind, a daily review on the global market trends is of utmost importance. There are mutual fund companies that invest your premiums on key performing institutions in Asia, Europe, the UK, South America, and more.



When an individual invests in mutual funds, he has the opportunity to own units of shares from hundreds of companies. However, we might fail to take a closer look at how our overall portfolio looks like. However, we do both know that you do not want to duplicate your holdings in your portfolio.

Say for example you have two investment vehicles, a mutual fund and an exchange-traded fund (ETF), for your retirement plan. The ETF is a collection of securities that tracks an index, which means that you own and can sell shares from companies in the NASDAQ-100, for example.

If your mutual fund already has a specific percentage of stocks from the technology sector, you may not want to have an ETF with the same percentage of shares from various information technology firms. This defeats the purpose of diversifying your portfolio in order to maximize returns and minimize risks.

To avoid this mistake, determine how much overlap you might have by reviewing your portfolio twice a year, typically in the summer and by the end of the year. Second, do not purchase two different funds or more run by the same money manager. Also, check the weightings of your funds. Similar weightings of two funds may mean they own many of the same exact stocks.

You can easily ask your mutual fund’s agent or their money manager about how your securities are allocated. However, with the right advisor, you can receive regular reports and analysis containing all of this information. Thanks to the internet data on the possibility of stock intersection are readily available online. There’s no better way of protecting your investments than having the right advisor consulting and guiding you. Regular risk and performance reviews will help you pinpoint your portfolio’s strengths and weaknesses.

Need Mutual Fund Help?

If you are among those seeking a more personalized and sound financial advice on investments in order to help you prepare for retirement, please feel free to book a consultation here, and we’ll be happy to help.  With the right tools, you can analyze your multiple funds’ holdings and expenses, asset allocation, sectors, and more.

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