While educating yourself on retirement investing strategies,these two terms likely come up often. And there are key reasons why. Keepreading to learn more.
What is a mutual fund?
A mutual fund is an investment opportunityallowing you to pool your money with that of other investors to purchasestocks, bonds, and other securities that you could not afford to invest inalone.
The higher your income, the more likely you’reinvesting in mutual funds: 84 percentof mutual funds are owned by the richest 10 percent — a fact that speaksvolumes about the financial possibilities of mutual funds.
What is a 401(k)?
A 401(k) is an employer-sponsored, tax-deferredretirement plan. The employer chooses the 401(k)’s investment portfolio, whichoften includes mutual funds. But amutual fund is not a 401(k).
What about taxes?
401(k) plans are usually tax deferred, meaningcontributions are taken from your pretax income. Taxes are only applied whenmoney is withdrawn from the account, typicallyduring retirement when you are likely in a lower tax bracket.
Mutual funds, in contrast, are generallypurchased with after-tax dollars. Income from the fund, including dividends andinterest, is taxable, as are any earnings when investments are sold.
Which should you invest in first?
If you prefer tax-deferred plans, your 401(k)should be maxed out first. This is especially true if your employer matches orcontributes to your 401(k). If you don’t takeadvantage of that match, you are basically throwingaway free money.
401(k)s have an annual contribution limit of$19,000. In contrast, there’s no limit to the number of mutual funds you canpurchase, making mutual funds an effective way to diversify your retirementportfolio.
The bottom line
A 401(k) and mutual funds can both play vital roles in your retirement savings plans. But don’t stop here! Head on over to our comprehensive guide to explore the many retirement plan options available to you.
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