index funds

How to Invest in Mutual Funds

Dr Penny Pincher — Fri, 02 Feb 2018 09:00:06 +0000

Mutual funds are an easy way to invest in a broad portfolio of stocks, bonds, and other securities. You don’t need to spend a lot of time picking individual stocks and making trades. Just invest in a mutual fund, and the mutual fund takes care of managing an investment portfolio for you.

There are thousands of mutual funds to choose from that contain different investment portfolios and fund features. Here are the most important types of mutual funds to consider to find the right ones for your portfolio.

Equity funds

Equity funds invest in stocks. You can choose an equity fund that specializes in certain types of stock investments, such as U.S. stock, international stock, growth stock, or value stock. Another variation is the size of companies that are targeted by the fund. Small-cap funds buy stock of smaller companies, mid-cap funds buy stock in midsize companies, and large-cap funds buy stock in large companies. Some equity funds specialize in stocks from specific sectors of the economy such as finance, energy, or health care.

Fixed income funds

Also known as bond funds, fixed income funds invest in debt issued by local and national governments and by large businesses. Bond funds are typically considered a lower risk alternative to stock investments, but offer less growth potential.

Balanced funds

Balanced funds invest in a mix of stocks and bonds. Many investors want to capture the growth potential of stock investments and the lower-risk income from bonds. A balanced fund provides a simple way to cover both stock and bond investments in a single fund.

Index funds

Index funds are designed to track a broader market such as the S&P 500. The main advantage of index funds over equity funds is that they typically have very low fund expenses since index funds require almost no management. (See also: Why Warren Buffett Says You Should Invest in Index Funds)

Target-date funds

Target-date funds adjust their asset allocation mix over time, from more aggressive investments to more conservative choices as the target date approaches. These funds are usually named with a date that represents the retirement or target year that the investor expects to begin accessing the funds. For example, “Freedom 2035” would target the year 2035 to reach its most conservative investment position. (See also: Start Planning Now for When Your Target-Date Fund Ends)

How to select the best mutual funds

Once you have identified the best types of mutual funds for your investment goals, you will need to select the specific mutual funds you want to purchase. Some of the key criteria to consider when evaluating funds are:

Investment objective: Do you want an aggressive growth fund that takes higher risks to seek higher returns, or would you rather have a more conservative fund that will be more likely to protect your investment?
Active vs. passive management: Do you want a fund with a fund manager making trades to try to maximize returns, or a passive fund that simply tracks a segment of the market?
Fees (expense ratio): Funds with lower fees are best for maximizing the growth of your investment over time, but some investment types are more complex and tend to have higher fees. Actively managed funds have higher fees than passive funds and index funds.
Performance record (return): While past performance does not predict future results, most investors tend to select funds with returns that have performed well compared to similar funds over the past one to five years.
Management team tenure: Some investors prefer funds that have had a consistent management team for a number of years.

You can do research to find funds that meet your investment objectives using online research tools at your stock broker’s website. Most brokers allow you to search for desired types of funds and review key information such as returns and fees. Some of the leading mutual fund brokerages include:

Fidelity

Vanguard

Merrill Edge
TD Ameritrade
E*TRADE
Charles Schwab

In case you don’t already have a broker, or if you want to check out a wider range of mutual fund offerings, here are some additional online mutual fund research tools to help you find and compare mutual funds:

How to buy mutual funds

After you have done your research and have selected a mutual fund that you want to buy, there are two ways you can make the trade and buy into the fund through a brokerage:

Execute an exchange to sell funds or stocks you currently own and use the proceeds to purchase the mutual fund you want to buy.
Transfer cash funds to your brokerage to execute a trade to buy the mutual fund you want.

You may be able to achieve tax advantages if you purchase mutual funds as part of an IRA or 401(k) retirement plan. After you buy a mutual fund, you should monitor the performance of the fund, its fees, and whether or not the fund is still a good fit for your investment portfolio on at least an annual basis.

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This article is from Dr Penny Pincher of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Lucrative Climate Change Investments That Can Help Save the World

Christa Avampato — Mon, 11 Dec 2017 09:30:09 +0000

We all want to do better to help our environment. Most of us know about small changes we can make, such as driving less or recycling more, to reduce the threat of climate change. But what if you want to do more? What if you could use your investment dollars to help fight climate change's impact on the world?

You can do this. Impact investing, which yields both a financial and social return, is increasing in popularity. Once considered an investment option only for people with significant financial means, impact investing is becoming more accessible to middle income earners. Here are five options that are worthy of your consideration if you want to take care of your own finances and the planet. (See also: A Simple Guide to Socially Responsible Investing)

1. Motif Investing's Climate Change Index Fund

Motif's Climate Change Index Fund is comprised of 25 stocks that include companies in clean energy, energy management, agriculture, clean water distribution, carbon emissions reduction, and waste management. Over the past year, the fund has had a return rate of 31.5 percent. In addition to the Climate Change investment option, Motif also has investment options that focus on fair labor practices and ethical corporate behavior.

2. Etho Climate Leadership Index

Etho Climate Leadership is the first index of its kind to be fully divested from fossil fuels. It selects the most carbon efficient companies across a wide variety of industries. In addition to eliminating fossil fuels, it has also eliminated investments from tobacco, weapons, and gambling. The index undergoes a rigorous screening process of its investments that is based on ESG (environment, social, and governance) performance data and incorporates expertise from global NGO (nongovernmental organization) partners.

3. Fidelity's U.S. Sustainability Index Fund

Fidelity created the U.S. Sustainability Index Fund to give its investors access to domestic companies that have strong sustainability profiles. Currently, the fund's top holdings include Microsoft, Johnson & Johnson, and Alphabet (Google). This fund has low expenses and a medium risk rating. Because it's new this year, this fund doesn't have deep historical performance data. However, it has provided an 11.70 percent lifetime return since its inception in May 2017.

4. Vanguard's FTSE Social Index Fund

Vanguard offers a host of socially responsible investment funds. Over the past decade, its FTSE Social Index Fund has seen peaks and troughs in its performance — though this year it has provided the best return in its history at 20.41 percent.

5. Wunder Solar Funds

Wunder Capital is a different breed of investment vehicle than the others mentioned above. For a minimum $1,000 investment, any investor can contribute to Wunder's efforts to loan money to small- and medium-sized businesses that want to install solar energy systems. The return has varied between 6 percent and 8.5 percent, depending upon the fund the Wunder investor chooses. This year alone, Wunder has financed 50 installations. Those 50 installations have yielded 15.2 megawatts of solar energy. What kind of impact does this change have on the environment? This carbon offset in this year alone is equivalent to:

14,248,648 pounds of burned coal.
1,502,503 gallons of gasoline consumed.
8,476,000 pounds of waste.
12,640 acres of U.S. forests.
2,821 cars driven.

These are just a handful of ways that you can use your investment dollars to provide you with a financial return while helping to fight climate change at the same time. As always, before investing it's wise to consult an investment professional so that you understand the risk/reward ratios of different options and to receive comprehensive advice on all of the investment options available to you.

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This article is from Christa Avampato of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

It's So Simple: 6 Steps to a Stable Retirement

Emily Guy Birken — Tue, 31 Oct 2017 09:00:06 +0000

If you are new to personal finance, you might find yourself thinking that reaching retirement is sort of like reaching a mythical place like Hogwarts. In both cases, the process required for entry is never adequately explained — and getting there yourself feels more like fantasy than reality.

While it's unlikely that an owl will ever arrive to welcome you to a magical school, retirement is actually attainable for each and every muggle. In fact, the rules for reaching a stable retirement are relatively simple and require absolutely no financial wizardry on your part,

Here are the only six things you need to do to achieve a stable retirement — no magic wands required.

1. Always spend less than you earn

No matter how much you make, you need to live on less than you earn. This is the kind of so-simple-it-feels-obvious advice that many personal finance experts take for granted, but keeping your expenses below your income is the cornerstone of saving for a stable retirement. Many people assume that they need to make a certain level of income before they can afford to start saving for retirement, but that's not true. As long as you always spend less than you earn, you can always save toward your retirement.

If you're not sure how to go about reducing your expenses so that you're no longer spending everything that comes in, start by tracking your spending. This will help you better understand where your money is going so you can cut back on unnecessary spending. (See also: Save More and Spend Less by Increasing Your "Mental Transaction Costs")

2. Max out your retirement contributions

Both your employer-sponsored 401(k) and your individual retirement account (IRA) have yearly contribution limits that you should strive to meet every year. The 2017 contribution limits are $18,000 for 401(k) plans (plus an additional $6,000 in catch-up contributions if over age 50), and $5,500 for IRAs ($6,500 if over age 50). The traditional versions of these investment vehicles are tax-deferred, which means you are funding your accounts with pretax dollars. Roth 401(k) plans and IRAs are funded with money you have paid taxes on, but they, like the traditional vehicles, grow tax-free.

Many people can't afford to meet the full contribution limit for their 401(k) plan, plus maxing out an IRA as well. However, getting as close to the maximum contribution as you can for both of these vehicles will put you well on your way to retirement stability. In addition, many employers offer a 401(k) contribution match — and not maxing out this kind of matching program is akin to leaving free money on the table. (See also: How Much Should You Have Saved for Retirement by 30? 40? 50?)

3. Work at least 35 years

While retiring early is a common dream among many workers, leaving the workforce before putting in 35 full years of employment could damage your bottom line in retirement. That's because your Social Security benefits are calculated using the 35 highest earning years in your career. If you have less than 35 years of work experience, the Social Security Administration uses zeros to create your benefit calculation, lowering your average earnings and your payout. If you don't have 35 years of employment history, it's a good idea to keep working to get those zeros replaced in your Social Security calculation.

Doing whatever you can to increase your monthly benefit will make a big difference in your bottom line once you retire. The most important increase you can make is to work at least 35 years total — although waiting as long as you can to take Social Security benefits is also an important strategy for increasing your monthly Social Security check. (See also: 6 Smart Ways to Boost Your Social Security Payout Before Retirement)

4. Avoid debt

We live in a society that tells us we can have it all right now and pay for it later. The problem is that we will indeed pay for it later — with an impoverished retirement. While it may be possible to finance the lifestyle you want with debt, you will have no money available to save for retirement or otherwise invest. In addition, the added interest expense of borrowing money to pay for your lifestyle just makes it that much more expensive and unsustainable. (See also: 5 Ways to Pay Off High Interest Credit Card Debt)

5. Invest for the long-term with index funds

While the movies show investing as a kind of game that you win by figuring out when to buy low and sell high, the best way to make sure your money grows is to follow a long-term buy-and-hold strategy.

A 2016 DALBAR study on investment behavior revealed that investors routinely underperform the market despite solid annualized returns. For example, at the end of 2015, the S&P 500 was averaging a return of 8.19 percent. That same year, investors saw returns top out at a measly average 4.67 percent — and this pattern is not new. Why such a discrepancy? Simple; rather than employing a buy-and-hold strategy, investors routinely try (and fail) to time the market. Year after year, their returns suffer as a result.

You can use statistics and a long investment term to your advantage by investing in index funds. These funds aim to replicate the movement of specific securities in a target index, which means an index fund is going to do about as well as the target securities will do. (See also: Want Your Investments to Do Better? Stop Watching the News)

6. Take care of your health

Your health can have an enormous impact on your financial stability in retirement. That's because health care costs are a major concern in your older years, especially since this is one aspect of your retirement budget that you may not have control over. According to a 2016 Fidelity study, a 65-year-old couple retiring in 2016 will need about $260,000 to cover their medical and health care costs for the rest of their lives.

While kale smoothies and daily kettlebell workouts cannot ensure your good health in retirement, taking good care of yourself throughout your life does improve the odds that you'll stay healthier as you age. You can consider each jog and healthy meal as an investment in your future. (See also: Don't Let Poor Health Kill Your Retirement Fund)

Reaching retirement, one step at a time

Achieving a stable retirement doesn't require any magic. Instead, it's a matter of following some simple rules that will ensure you have the money you need to retire comfortably.

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This article is from Emily Guy Birken of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

4 Retirement "Rules of Thumb" That Actually Work

Damian Davila — Tue, 09 May 2017 09:00:10 +0000

Planning for retirement can sometimes feel daunting, but there are ways to temper these worries. Over the years, financial experts have come up with several useful rules of thumb that can help you get your finances organized. To be sure, there is no one-size-fits-all approach to retirement savings, but these strategies are a great place to start.

1. The 50/30/20 rule

You may know Senator Elizabeth Warren for her fiery speeches on and off the floor of the U.S. Senate, but she is also a serial author with 12 books under her belt. Teaming up with her daughter, Amelia Warren Tyagi, Warren provides practical budgeting advice in All Your Worth: The Ultimate Lifetime Money Plan.

The golden nugget from Warren's book is the 50/30/20 rule, which suggests that you split your budget into three buckets:

50 percent to pay for must-haves, including rent or mortgage payments, groceries, and minimum debt payments;
30 percent to cover non-essentials, such as going to the movies or on vacation; and
20 percent to save for retirement, build an emergency fund, and make additional debt payments.

The 50/30/20 rule has become very popular because it strikes a balance between wants and needs, and provides a simple approach to setting your monthly budget. Assuming a monthly paycheck of $2,800 after taxes, you would allocate $1,400 ($2,800 x 50 percent) to needs, $840 ($2,800 x 30 percent) to wants, and $560 ($2,800 x 20 percent) to debt and/or your retirement fund.

2. At least 10 percent of your income to retirement savings

There's another rule of thumb for how much of your income should go specifically toward retirement. According to many financial advisers, you should contribute at least 10 percent of your paycheck to your 401(k), IRA, or workplace savings plan.

Why is 10 percent a rule of thumb? One possible explanation is the ease of calculation: Just take out a zero. With a gross monthly paycheck of $3,500, you know that you have to contribute $350 to your retirement account. Easy!

A caveat here is that you should be doing this for as long as you are working, starting as soon as possible. Young retirement savers will benefit the most because of compounding interest. The more that you contribute to your retirement account in your early working years, the more time the funds will have to grow.

3. The 90/10 rule from Warren Buffett

In 2013, legendary investor Warren Buffett revealed that he ordered the trustee of his estate to allocate 90 percent of his cash to a very low-cost S&P 500 index fund, and the remaining 10 percent to short-term government bonds. "I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers," he concluded. (See also: Why Warren Buffett Says You Should Invest in Index Funds)

This advice didn't go unnoticed by investors. Between 2011 and 2016, investors took $5.6 billion out of actively managed funds, which attempt to beat the market, and dumped $1.7 trillion into passively managed funds, such as index funds. As the name implies, index funds simply aim to generate a return equal to the index they're tracking, such as the S&P 500, after fees.

Putting 90 percent of your retirement savings in a low-cost index fund greatly minimizes your investment costs, since the expense ratios (the annual fees charged to shareholders) are much less than for actively managed funds. This means more money is left in your account to grow, and therefore you increase your chance of hitting your savings target. Some equity index funds have annual expense ratios as low as 0.05 percent, and those tracking the S&P 500 had an average annual return of 8.65 percent over the 2007–2016 period.

As you get closer to retirement age, you may want to consult with a financial professional on how to adjust your portfolio allocation according to your changing needs.

4. The 4 percent rule

After testing a variety of retirement withdrawal rates using historical rates of return, financial planner William Bengen determined that four percent was the highest rate that held up over a period of at least 30 years.

Here's how it works: Assuming a $600,000 nest egg, you would withdraw $24,000 in your first year of retirement. In the second year, you would withdraw the same amount plus extra to cover inflation. Assuming an annual rate of inflation of 2.5 percent, your second and third withdrawals would be $24,600 and $25,215, respectively.

While the four percent rule is not without critics, nor is it the perfect calculation for everyone, it continues to help retirees plan ahead the size of their withdrawals during their retirement years. Just make sure that once you reach age 70 ½, you meet your required minimum distributions (RMDs) set by the IRS. Some years you may have to withdraw a bit extra beyond your planned four percent to avoid the hefty 50 percent tax penalty for failing to take your scheduled RMD.

The bottom line

These four rules of thumb can give you a leg up on your retirement strategy. However, think of them more as guidelines and not so much as commandments. Every financial situation is different, so make the most of the available information and resources through your employer-sponsored retirement plan. Consult a financial adviser whenever necessary. (See also: Who to Hire: A Financial Planner or a Financial Adviser?)

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Why Warren Buffett Says You Should Invest in Index Funds

Dr Penny Pincher — Mon, 10 Apr 2017 09:00:08 +0000

About nine years ago, Warren Buffett made a $500,000 bet. He wagered that a simple index fund would outperform an actively managed hedge fund run by expert investors. Which would you pick?

Before you decide, here is some additional information about the fund contenders:

Index funds buy a mix of stocks in a proportion that represents the overall stock market or a particular market segment. Index funds are typically managed automatically by a computer algorithm, and management fees for this type of fund are usually very small — around 0.1 percent or sometimes even lower.
Hedge funds put money into alternative investments that can go up if the stock market goes down. Of course, hedge funds also try to provide maximum returns and beat the stock market if possible. Hedge funds may invest in real estate, commodities, business ventures, and other opportunities that fund managers think will hedge against potential stock market losses and produce good returns. These funds are actively managed and have high management fees of around 2 percent or more.

Buffett picked a simple S&P 500 index fund for the wager. He bet against an investment manager who picked a set of five hedge fund portfolios. After letting these investments play out for nine years, Buffett announced the results of this wager in the chairman's letter in this year's annual report for the holding company he controls and runs, Berkshire Hathaway: The index fund outperformed the actively managed funds. (See also: The 5 Best Pieces of Financial Wisdom From Warren Buffett)

Buffet's experience mimics numerous studies that have shown that index funds consistently beat the results of actively managed funds. Why does a simple and essentially automatic investment strategy (the index fund) outperform sophisticated investment funds managed by active expert investors?

Low fees

Fund fees, also known as expense ratios, are much lower for index funds than for actively managed hedge funds or mutual funds. You can find index funds with fees under 0.1 percent, while actively managed hedge funds can have fees of 2 percent or more.

Although the wager Buffett made concerned hedge funds with high expense ratios, the same principle applies when comparing index funds to actively managed mutual funds, which can have fees as high as 1 percent. Higher fees mean that actively managed funds have to outperform the market significantly to offset them. Over the long run, actively managed funds may not consistently outperform the market by enough to make up for the higher fees.

Investment errors

Another reason actively managed funds can fall behind index funds is investment errors. In active funds, someone is making investment decisions and moving money around trying to get higher returns. Sometimes an investment manager can outperform the market and get higher returns, but this doesn't always work out. It only takes one mistake to wipe out a lot of investment gains. In an index fund, the only investment decision is to adjust the ratio of holdings to match the market segment of interest.

Index funds accurately reflect the performance of the market they are mirroring. The investment strategy is simple, and there is no opportunity for investment error. If you invest in an index fund, you will reliably receive similar returns to the market that your index fund represents.

How to buy an index fund for your portfolio

During my research for this article, I moved around $10,000 of my own investment funds from actively managed funds into index funds with much lower fees. I figured if index funds are good enough for Warren Buffett, they are good enough for me!

You can log in to your investment account website and view the expense ratios for your current investments and for other available funds. I found that my investment choices had expense ratios ranging from 0.02 percent to 0.83 percent — a difference of more than 40-fold. This is definitely a big enough difference to worry about.

A good first step is to check your own investment funds and find out how high the fees are. You may be happy with what you find, or you may decide you want to move to index funds with much lower fees.

Of course, when choosing your investment funds, you shouldn't look only at the expense ratio. You should balance your portfolio to include a strategic mix of large cap, medium cap, and small cap investments and an intentional balance of foreign and domestic stocks to meet your investment goals.

When I moved my investment money into index funds with very low fees, I picked funds that made sense to balance my portfolio. For example, I moved some funds from a mid-cap growth fund with a 0.3 percent expense ratio into a mid-cap index fund with a 0.07 percent expense ratio — over four times lower fees. In the long run, I think this is a bet that will pay off.

Even if you don't have $500,000 to wager, you might as well minimize what you are paying in fees by moving from actively managed funds to index funds. You'll keep more of your money working for you instead of having it go to work for someone else.

This article is from Dr Penny Pincher of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Traps to Avoid With Your 401(k)

Damian Davila — Thu, 23 Mar 2017 09:00:15 +0000

More and more Americans are choosing an employer-sponsored 401(k) as their preferred way to build up their nest eggs. As of 2014, an estimated 52 million Americans were participating in a 401(k)-type plan.

When used properly, a 401(k) can be a powerful tool to save for your retirement years, but there are a couple of crucial pitfalls that you have to watch out for. From high fees to limited investing choices, here is a list of potential downsides to 401(k) plans — and how to work around them.

1. Waiting to set up your 401(k)

Depending on the applicable rules from your employer-sponsored 401(k), you may be eligible to enroll in the plan within one to 12 months from your start date. If your eligibility kicks in around December, you may think that it's fine to wait until the next year to set up your retirement account.

This is a big mistake for two main reasons.

First, contributing to your 401(k) with pretax dollars allows you to effectively reduce your taxable income for the current year. In 2017, you can contribute up to $18,000 ($24,000 if age 50 or over) to your 401(k), so you can considerably reduce your tax liability. For example, if you were to contribute $3,000 between your last two paychecks in December, you would reduce your taxable income by $3,000. Waiting until next year to start your 401(k) contribution would mean missing out on a lower taxable income!

Second, your employer can still contribute to your 401(k) next year and make that contribution count for the current year, as long as your plan was set up by December 31 of the current year. Your employer contributions have to be in before Tax Day or the date that you file your federal taxes, whichever is earlier.

How to work around it

If you meet the requirements to participate in your employer-sponsored 401(k) toward the end of the year, make sure to set up your account by December 31st. That way, you'll be ready to reduce your taxable income for the current year through your own contributions and those from your employer before their applicable deadline (December 31 and Tax Day or date of tax filing (whichever is earlier), respectively).

2. Forgetting to update contributions

When you set up your 401(k), you have to choose a percentage that will be deducted from every paycheck and put into your plan. It's not uncommon that plan holders set that contribution percentage and forget it. As your life situation changes, such as when you get a major salary boost, marry, or have your first child, you'll find that your contributions may be too big or too small. (See also: 5 Times It's Okay to Delay Retirement Savings)

How to work around it

To keep a contribution level that is appropriate to your unique financial situation, revisit your percentage contribution every year and whenever you have a major life change. Don't forget to also check whether or not you elected an annual increase option — a percentage by which your contribution is increased automatically each year — and adjust it as necessary.

3. Missing out on maximum employer match

Talking about contributions, don't forget that your employer may contribute to your plan as well. In a survey of 360 employers, 42 percent of respondents matched employee contributions dollar-for-dollar, and 56 percent of them only required employees to contribute at least 6 percent from paychecks to receive a maximum employer match.

How to work around it

Employers require you to work a minimum period of time before starting to match your contribution. Once you're eligible, meet the necessary contribution to maximize your employer match. One estimate puts the average missed employer contribution at $1,336 per year. This is free money that you can use to make up for lower contribution levels from previous months or years.

4. Sticking only with actively managed funds

When choosing from available funds in their 401(k) plan, account holders tend to focus on returns. There was a time in which actively managed funds were able to deliver on their promise of beating the market and delivering higher-than-average returns. That's why 401(k) savers often choose them.

However, passively managed index funds — funds tracing an investment index, such as the S&P 500 or the Russell 2000 — have consistently proven that they can beat actively managed funds. Over the five past years, only 39 percent of active fund managers were able to beat their benchmarks, which is often an index. That's why over the same period, investors have taken $5.6 billion out of active funds and dumped $1.7 trillion into passive funds.

How to work around it

Find out whether or not your 401(k) offers you access to index funds. Over a long investment period, empirical evidence has shown that index funds outperform actively managed funds. Review available index funds and choose the ones that meet your retirement strategy. (See also: 3 Steps to Getting Started in the Stock Market With Index Funds)

5. Chasing high returns instead of lower costs

When reading the prospectus of any fund, you'll always find a disclaimer warning you that past returns aren't a guarantee of future returns. So, why are you holding onto those numbers so dearly? As early as 2010, investment think tank Morningstar concluded that a fund's annual expense ratio is the only reliable indicator of future investment performance, even better than the research firm's well-known star rating.

And guess what kind of funds have the lowest annual expense ratios? Index funds! For example, the Vanguard 500 Index Investor Shares fund [Nasdaq: VFINX] has an annual expense ratio of 0.16 percent, which is 84 percent lower than the average expense ratio of funds with similar holdings. If your 401(k) gives you access to lowest cost Vanguard Admiral shares, you would shed down that annual expense ratio even further to 0.05 percent.

How to work around It

When evaluating a fund in your 401(k), look for comparable alternatives, including index funds. To maximize the growth of your nest egg, chase funds with lower annual expense ratios and investment fees. Regardless of their performance (which tends to be better anyway!), you'll minimize your investment cost. (See also: Watch Out for These 5 Sneaky 401(k) Fees)

6. Not periodically rebalancing your portfolio

Even when choosing index funds, you still need to periodically adjust your portfolio. Let's assume that you follow this investment recommendation from Warren Buffett for your 401(k): 90 percent in a low-cost index fund, and 10 percent in government bonds. (See also: The 5 Best Pieces of Financial Wisdom From Warren Buffett)

Depending on the market, your portfolio allocation may be way off as early as one quarter. If the S&P 500 were to have a huge rally, you may now be holding 95 percent of your 401(k) in the index fund. That would be much more risk that you may be comfortable with, so you would need to take that 5 percent and put it back into government bonds. On the other hand, holding 85 percent in government bonds would make you miss your target return for that year. Forgetting to rebalance your portfolio once a year when necessary is one easy way to derail your saving strategy.

How to work around it

Many 401(k) plans offer an automatic annual rebalancing feature. Review the fine print of this feature with your plan and decide whether or not it's suitable for you. If your plan doesn't offer an automatic rebalancing feature, choose a date that makes the most sense to you and set it as your day to rebalance your portfolio every year.

7. Taking out 401(k) loans

Treating your 401(k) as a credit card is a bad idea for several reasons. Doing this:

Creates additional costs, such as origination and maintenance fees;
Becomes due in full within 60 days of separating from your employer;
Turns into taxable income when not paid back, triggering potential penalties from the IRS and state and local governments; and
May quickly turn into a bad habit: 25 percent of 401(k) borrowers go back for a third or fourth loan, and 20 percent of them take out at least five loans.

How to work around it

Treat your 401(k) as a last-resort source of financing. There are very few instances when you should borrow from your retirement account. Make sure that you go through all of your credit options and include the opportunity cost of foregoing retirement savings, including potential taxes and penalties, when comparing a 401(k) loan against another type of loan.

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

15 Retirement Terms Every New Investor Needs to Know

Damian Davila — Thu, 17 Nov 2016 11:00:14 +0000

Congratulations! By starting your retirement fund, you've taken one of the most important steps toward a comfortable retirement. But as a novice investor, you may feel a bit overwhelmed with all the available information, including contribution limits, early penalty fees, and Roth 401Ks. To help you make sense of it all, let's review 15 key terms you should know:

1. 401K

The 401K is the most popular qualified employer-sponsored retirement plan in the U.S. The two most common types of 401K plans are the traditional 401K, to which you contribute with pretax dollars, and the Roth 401K, which accepts contributions with after-tax dollars. Earnings in a traditional 401K grow on a tax-deferred basis (you'll pay taxes on the funds when you withdraw them during retirement) and those in a Roth 401K grow tax-free forever, since you've paid taxes upfront.

2. After-Tax Contributions

Only certain types of retirement accounts, such as Roth 401Ks and Roth IRAs, accept contributions with after-tax dollars. When you contribute to a retirement account with after-tax dollars, your retirement funds grow tax-free forever, since you've already paid Uncle Sam.

3. Catch-Up Contribution

Retirement investors who are 50 and older at the end of the calendar year can make extra annual "catch-up" contributions to qualifying retirement accounts. Catch-up contributions allow older savers to make up for lower contributions to their retirement accounts in earlier years. In 2016 and 2017, catch-up contributions of up to $6,000 (on top of traditional annual contribution limits) are allowed for 401Ks and up to $1,000 for IRAs.

4. Contribution Limits

Every year, the IRS sets a limit as to how much you can contribute to your retirement accounts. In 2016, you can contribute up to $5,500 ($6,500 if age 50 or over) to traditional and Roth IRAs and up to $18,000 ($24,000 if age 50 or over) to a traditional or Roth 401K. These annual contribution limits to retirement accounts remain unchanged for 2017. If you exceed your contribution limit, you'll receive a penalty fee from the IRS, unless you take out excess moneys by a certain date.

5. Early Distribution Penalty

To discourage retirement savers from withdrawing funds before retirement age, the IRS imposes an additional 10% penalty on distributions before age 59 ½ on certain retirement plans. Keep in mind that you're always liable for applicable income taxes whether you take a distribution from your retirement plan before or after age 59 ½. Under certain circumstances, you're allowed to withdraw money early from a retirement account without the penalty.

6. Fee

You've heard that there is no such thing as a free lunch and no retirement plan is exempt from this rule. There's always a cost for the employer or employee, or both. Always check the prospectus from any fund for its annual expense ratio and any other applicable fee. An annual expense ratio of 0.75% means that for every $1,000 in your retirement account, you're charged $7.50 in fees. And that's assuming that you don't trigger any other fees! (See also: Watch Out for These 5 Sneaky 401K Fees)

7. Index Fund

An index fund is a type of mutual fund that tracks of a basket of securities (generally a market index, such as the Standard & Poor's 500 or the Russell 2000). An index fund is a passively managed mutual fund that provides broad market exposure, low investment cost, and low portfolio turnover. Due to its low annual expense ratios, such as 0.16% for the Vanguard 500 Index Investor Shares [Nasdaq: VFINX], index funds have become a popular way to save for retirement. (See also: 3 Steps to Getting Started in the Stock Market With Index Funds)

8. IRA

Unlike a 401K, an individual retirement account (IRA) is held by custodians, including commercial banks and retail brokers. The financial institutions place the IRA funds in a variety of investments following the instructions of the plan holders. A traditional IRA accepts contributions with pretax dollars, and a Roth IRA accepts contributions with after-tax dollars. An advantage of using a Roth IRA is that it provides several exemptions to the early distribution penalty.

9. 401K Loan

Some retirement plans allow you to take a loan on a portion of your available balance — generally, 50% of your vested account balance, or up to $50,000, whichever is less. While the loan balance is generally due within five years, it becomes fully due within 60 days from separating from your employer. (See also: 5 Questions to Ask Before You Borrow From Your Retirement Account)

10. Mutual Fund

By pooling funds from several investors, money managers are able to invest in a wide variety of securities, ranging from money market instruments to equities. Investing in a mutual fund enables an individual retirement investor to gain access to a wide variety of investments that she wouldn't necessarily have access to on her own. Depending on its investment strategy, mutual funds can have a wide variety of fees. So, make sure to read the fine print. (See also: 4 Sneaky Investment Fees to Watch For)

11. Pretax Contribution

When you contribute to your employer-sponsored retirement account with pretax dollars, you're allowed to reduce your taxable income. For example, if you were to make $50,000 per year and contribute $5,000 to your 401K with pretax dollars, then you would only have to pay applicable income taxes on $45,000! You delay taxation until retirement age when you're more likely to be in a lower tax bracket.

12. Required Minimum Distribution (RMD)

You can't keep moneys in your retirement account forever. At age 70 ½, you generally have to start taking withdrawals from an IRA, SIMPLE IRA, SEP IRA, or 401K. An RMD is the minimum amount required by law that you have take out from your retirement account each year to avoid a penalty from the IRS. You can use of one of these requirement minimum distribution work sheets to calculate your RMD.

13. Rollover

When you separate from your employer, you generally have up to 60 days to transfer moneys in your previous retirement account to a new retirement account accepting those moneys. This process is known as a rollover. In a direct rollover, the process is automatic; in an indirect rollover, you receive a cash-out check from your previous employer to rollover the moneys to a new qualifying retirement account. (See also: A Simple Guide to Rolling Over All of Your 401Ks and IRAs)

14. Target-Date Fund

A target-date fund is a retirement investment fund that seeks to provide higher returns to young investors and gradually reduce risk exposure as they get closer to retirement age. Since the Pension Protection Act granted target-date funds the status of qualified default investment alternative in 2006, these type of funds have gained popularity. About half of 401K participants hold a target-date fund.

15. Vesting

In any retirement account, only money that is fully vested truly belongs to you. While all of your contributions and the matching contributions from your employer to your retirement account are always fully vested, some employer contributions, such as company stock, may follow a vesting schedule. In cliff vesting, you only become fully vested after a certain period of time. In graded vesting, you gradually gain ownership of those employer contributions.

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This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

What Are Income Stocks?

Damian Davila — Thu, 20 Oct 2016 09:30:23 +0000

You may think that investing in stocks is all about share price increases over time. In reality, you may be surprised to find out that the price of some stocks can vary little over time and still provide an ever-increasing stream of income. These types of securities are known as income stocks.

Let's review the seven things you need to know about income stocks and their ability to provide a high payout to investors.

1. They Pay a Dividend

The defining feature of an income stock is that it pays a regular and predictable dividend, which often increases over time. For example, Caterpillar Inc. [NYSE: CAT], a leading manufacturer of construction, mining, and transportation equipment, has paid a dividend to its stockholders every quarter since 1933. For the last 22 years, Caterpillar's cash dividend has consistently increased and it stands at $0.77 per share of common stock — up from $0.35 in 1996, and without adjusting for the two-for-one stock splits of 1997 and 2005.

A predictable, steady, and ever-increasing stream of income makes income stocks attractive to those retirement savers who're close to retirement age.

2. They Are Often Large Companies

While income stocks can be found in many industries, they are most often part of the real estate, energy, utility, natural resource, and finance industries. One example of an income stock in the energy sector is Phillips 66 [NYSE: PSX], which has been in the news due to its spinoff from ConocoPhillips back in 2012. It doubled its stock price in the first year after the spinoff, and attracted Warren Buffett's investment (a 15.2% share of the company as of late August 2016). (See also: The 5 Best Pieces of Financial Wisdom From Warren Buffett)

The Houston-based multinational energy company generated $161.2 billion in revenue in 2014, a figure that is bigger than the GDP of some nations around the world. Since its 2012 spinoff, Phillips 66 has been consistently paying a quarterly dividend that started at $0.20 per share of common stock and stands now at $0.63 per share of common stock.

3. They Have Been in Business for a Long Time

Generally speaking, the less established a company, the more likely that company can experience extraordinary growth per quarter. Think of 12-year-old Facebook or 13-year-old Tesla, whose current stock prices are seven and 10 times, respectively, their original prices after going public. Both Facebook and Tesla would be considered growth stocks. On the other hand, income stocks are those of companies with a long history. Caterpillar and Phillips 66 were originally founded back in 1925 and 1917, respectively. (See also: What Are Growth Stocks?)

4. They Are an Alternative to Fixed-Income Securities

If you have a 401K, chances are that you have a target-date fund. In 2014, 48% of 401K plan holders had target-date funds, which gradually lowers exposure to risk as you get closer to retirement age and helps maintain a steady stream of income during your retirement years. However, dialing back your risk doesn't necessarily mean that you will stick to municipal bonds and money market accounts from now on.

Legendary investor Peter Lynch said it best: "Gentlemen who prefer bonds don't know what they're missing." The appeal of income stocks is that they provide a steady stream of income while providing some exposure to corporate profit growth. Many investors use the yield of a 10-year treasury bond rate as a benchmark to grade the performance of income stocks. As of October 10, 2016, the yield of a 10-year treasury bond was 1.77% and those from Phillips 66 and Caterpillar were 3.13% and 3.48%, respectively.

5. They Have Modest Annual Profit Growth

That being said, don't expect companies behind income stocks to have ambitious goals of profit growth. Due to its long business history, some income stocks may have limited future growth options and provide only a moderate annual profit growth. However, this is the main reason why these companies are able to pay a dividend in the first place. Since there may be no need to aggressively reinvest in new infrastructure, research, or development, then the company can afford to issue a dividend every quarter to its shareholders.

6. They Have Low Stock Price Volatility

Among the many statistics that analysts report on stock tables, beta is one of the most relevant ones, besides dividend and yield, to incomes stocks. (See also: Beginner's Guide to Reading a Stock Table)

Since the beta of the market as a whole is 1.0, a stock with a beta below 1.0 would move less than the market, and a stock with a beta above 1.0 would deviate more than the market. Often, income stocks have betas below 1.0. For example, machinery manufacturer Deere & Company [NYSE: DE] has a beta of 0.63, and retailer Wal-Mart Stores Inc. [NYSE: WMT] has one of 0.09.

7. They Are Available in Mutual Funds and Index Funds

Even though throughout this article we have only focused on individual companies, you can still buy a basket of several income stocks at the same time. You can do this through either a mutual fund or a low-cost index fund. One example of the second category is the Vanguard High Dividend Yield Index Fund Investor Shares [Nasdaq: VHDYX], which holds many income stocks, such as Microsoft, Exxon, Johnson & Johnson, and General Electric.

Two advantages of using index funds to include income stocks in your portfolio are diversification (e.g. 420 holdings in the mentioned index fund from Vanguard) and low cost (e.g. 0.16% annual expense ratio for the same index fund).

The Bottom Line

Before buying an income stock, make sure to evaluate it using your current investment strategy. While an income stock can offer you a way to get higher yields than those of treasury securities or certificates of deposit, you may be so far away from retirement age that you could afford a higher exposure to risk through value or growth stocks. Consult with your financial adviser to discuss more about your investment objectives and the appropriate ways to achieve those financial goals.

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Best Money Management Tips From John Oliver

Emily Guy Birken — Mon, 08 Aug 2016 10:30:07 +0000

I don't often admit to it, but I have a little crush on comedian and Last Week Tonight host, John Oliver. I mean, what's not to like? There's his adorable British accent, his hilarious takes on the modern world, his dimples, his sound money advice…

No, really. John Oliver is actually a pretty solid source for financial tips. Over the past few years, he has cemented his place in my heart by using his comedic platform to educate his audience on everything from credit scores to debt management and retirement savings

If you haven't had a chance to watch all of John Oliver's money-related episodes, here are my favorite financial funnyman's seven best money management tips:

1. Before Taking a Payday Loan, Be Absolutely Sure There Are NO Other Options

As seen on: Last Week Tonight: Predatory Lending

Wise Bread readers are likely very well aware of the predatory nature of payday loans. Taking a short-term loan can kick off a terrible cycle of debt with annual interest rates as high as 700%. But, as John Oliver points out in his rant, a Pew survey found that "a majority of borrowers say payday loans take advantage of them, [but] a majority also say they provide relief."

The point is that there will be times when people need money in a hurry and feel that their choices are limited. However, most borrowers have more choices than they think they do. Prospective payday loan customers could always borrow from a family member or friend, pawn or sell an item, or even sell blood or plasma. In other words, it's a better idea to do almost anything else to generate some quick cash than visit a payday loan store. (Although some of the ideas suggested by Sarah Silverman, the official spokesperson for doing anything else, are clearly meant to be tongue-in-cheek.)

Many payday loan borrowers end up turning to these anything else options in order to get out of the cycle of payday loan debt, so it would be better to just start there.

2. Start Saving for Retirement Now — And Build a Time Machine and Start Saving 10 Years Ago If Possible

As seen on: Last Week Tonight: Retirement Plans

We all need to be saving more money for retirement, and the earlier you start, the more time compound interest has to work its magic. According to a 2014 study from the Center for Retirement Research at Boston College, a 25-year-old would only need to set aside 15% of her income each year to adequately replace her income as of retirement at age 62 — but if she started at age 35 she would need to save 24%, and 44% if she waited until age 45.

While I have no issue with encouraging people to save more (really — save more!), I do have a quibble with the slight whiff of shame clinging to the build-a-time-machine portion of this advice. We can't change our past financial behavior, but we can feel bad about it and let it affect our present behavior — which too many people tend to do. There's no point in offering coulda-shoulda-woulda advice when time machine technology is still a couple of thousand decades away from reality.

However, the basis of this advice is more than sound. Don't waste your money on Elf School in Reykjavik. Put it in your retirement account where it can do you some real good.

3. Check Your Credit Report Every Year

As seen on: Last Week Tonight: Credit Reports

Your credit history can affect everything from whether you qualify to make large purchases, to your ability to land a job or rent an apartment. Unfortunately, credit reports are not always accurate, even if you have been a boy scout when it comes to your responsible credit usage.

As John Oliver reports, the credit reporting bureaus make major mistakes in one out of every 20 credit histories. That may be a 95% accuracy rate, but it does leave 10 million consumers to deal with critical mistakes on their credit reports.

The only thing we can do to fight mistakes (and identity theft, which Last Week Tonight did not even get into) is to regularly check our credit reports. We are legally allowed free access to a credit report from each of the major reporting agencies — TransUnion, Experian, and Equifax — once per year. You can access that information at annualcreditreport.com.

If you're particularly organized, you can keep an eye on your credit on a rolling basis by checking one of the three agencies every four months.

4. Invest in Low Cost Index Funds

As seen on: Last Week Tonight: Retirement Plans

Seeing this particular piece of advice had me standing up and cheering in front of my laptop. The financial industry likes to tout the superiority of actively managed funds since there is an individual making decisions for your investments — which has got to be better than doing nothing.

Except the active managers who are tinkering with investments have a couple of big detractions. First, they are human, which means they are subject to emotional reactions to market volatility. It is very hard to stick to a plan when ego, panic, or greed is driving the train. According to research by Nobel laureate William Sharpe, you would have to be correct about timing the market (that is consistently buying low and selling high) 82% of the time in order to match the returns you will get with a buy-and-hold strategy. To put that in perspective, Warren Buffett aims for accurate market timing about 2/3 of the time.

In addition to the difficulty of market timing, an actively managed fund will have higher transaction costs because of all the active buying and selling (each of which generates a fee) going on. Even if you have the world's most accurate active manager, a great deal of your returns will be eaten up by your transaction costs.

Low cost index funds, on other hand, keep their costs low by having fewer managers to pay, and they tend to outperform actively managed funds because they are simply set to mimic a certain index. The majority of consumers will not beat low cost index funds for satisfactory retirement investment growth.

5. If You Have a Financial Adviser, Ask if They're a Fiduciary

As seen on: Last Week Tonight: Retirement Plans

A financial adviser is a fiduciary if he or she is legally required to put your economic interests ahead of their own. This is an important distinction because the terms financial adviser, financial planner, financial analyst, financial consultant, wealth manager, and investment consultant are unregulated — which means someone introducing himself by any of these titles might not have the expertise to back it up.

But even if your financial adviser does have the credentials necessary to help you manage your money, she might be paid via commission, which could mean she recommends products to you that help her bottom line more than your retirement.

Since a fiduciary is legally obligated to put your interests above their own, you are more likely to get objective advice from them.

While John Oliver recommends running the other direction if you find that your financial adviser is not a fiduciary, that may not be necessary as long as you understand how your adviser is paid and you are willing to commit to due diligence in double-checking your adviser's recommendations.

6. Gradually Shift From Stocks to Bonds As You Get Older

As seen on Last Week Tonight: Retirement Plans

This advice is part of target-date retirement planning. The thinking behind it is that you need to be invested in riskier (and therefore higher-earning) investments like stocks when you are young, because you have the time to ride out the volatility and reap the returns. But as you age, you need to be sure your principal is protected, which means gradually shifting more of your investments into bonds, which are more stable but have lower returns.

This is pretty good general advice, and I love the show's take on when to remind yourself to shift more to bonds — whenever a new James Bond actor is chosen. (I'm team Gillian Anderson!)

The only nuance I would like to add to this piece of advice is to remind investors that retirement does not mark the end of your investing days — and you should not be entirely invested in bonds by then. Theoretically, you still have 25 to 40 years ahead of you as of the day you retire, and you will still need to be partially invested in aggressive assets like stocks in order to make sure your money keeps growing.

7. Keep Your Fees, Like Your Milk, Under 1%

As seen on Last Week Tonight: Retirement Plans

Except for the fact that skim milk is a watery horror I would not wish on my worst enemy's morning Wheaties, this is probably my favorite of John Oliver's money tips.

Fees on your investments work a lot like interest — in that they compound quickly. Last Week Tonight showed a clip from the 2013 PBS documentary The Retirement Gamble, which illustrated how compounding interest would eat up 2/3 of your investment growth over 50 years, assuming a 7% annual return and a 2% annual fee.

The only way to combat such termite-like destruction of your investment growth is to keep your fees low — under 1%. And the lower you can get your fees under 1%, the better you are. As John Oliver's segment points out, "Even 1/10 of 1% can really [bleep] you."

Money With a Side of Funny

The majority of financial information is not exactly fun to read through. That's why it's so important for a satirist and comedian to take on these vitally important issues and make them entertaining. I'm thankful that John Oliver has decided to make money one of the issues he illuminates for his audience.

Are you a regular watcher of Last Week Tonight? What valuable advice have you gleaned?

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This article is from Emily Guy Birken of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

How to Tell if Your 401K Is a Good or a Bad One

Tim Lemke — Fri, 05 Aug 2016 09:00:12 +0000

If you work for a company, there's a good chance that your employer offers a 401K plan. (Some organizations offer 403b plans, which operate similarly.) These funds give you the chance to invest in a series of mutual funds and other investments, with the added benefit that any money you contribute is deducted from your taxable income.

Not all 401K plans are the same, however, and there is a wide range in the amount of expenses and the quality of investments offered.

It's not easy to immediately know if your 401K plan is a good one, and whether it's worth putting money into. But here are some things to examine.

Do You Get a Company Match?

Arguably the most positive aspect of a 401K plan is the ability of companies to match a certain percentage of employee contributions. Typically, a company might agree to contribute up to 5% of a worker's earnings, if the worker does the same. This match is essentially free money, so it usually makes participating in the 401K plan a no-brainer, even when the plan is otherwise subpar.

If your company does not contribute to your 401K plan or offer a match, you'll want to examine other characteristics of the plan to determine whether it's worth it to contribute. You may find that contributing to a traditional or Roth IRA is a better alternative.

Examine the Investment Options

A 401K plan is only as good as the investment options in them. There's no perfect menu, but a strong plan is anchored by one or two mutual funds that mirror the broader stock market. These are called "index" funds, because they are designed to mirror the performance of a specific index, such as the S&P 500. A good plan will also have some large-cap, mid-cap, and small-cap funds, and the ability to access international and real estate investments. Older investors will want to see a selection of quality bond funds.

You'll want to look for a diverse array of investments, but there is a point at which more options aren't necessarily better.

"More funds can just confuse you," said Ralph Grauso, founder of ASC Financial. "You don't need three different types of large-cap growth funds."

Check the Fees

One of the most common criticisms of 401K plans is that they often contain funds with high expenses. The best 401K plans should offer access to the lowest cost funds available.

Management fees, plan operating expenses, and other costs can take a chunk out of your returns without you even being aware. Over time, that can lead to tens of thousands of dollars in lost earnings. A survey by AARP noted that 80% of 401K plan participants don't know what they are paying in fees. Most information on fees is available by reading plan and fund documents, but you may still have to do some digging.

"If you're investing for 30 years or more, those fees are going to take a huge chunk of your money," Grauso said.

Grauso said it's best to find funds with expense ratios of less than 1%. Index funds are particularly low in cost because they are not actively managed, and often perform better than managed funds anyway, he said. Look for low-cost index funds from a broker such as Vanguard, and stay away from niche funds with high costs.

Study the Fund Performance

Ultimately, you want to put your money in funds that will generate a nice return and help you develop a sizable nest egg. Predicting future performance is not possible, but you can get a good sense of the quality of a fund by examining its long-term performance.

Look at five-year and 10-year returns, and compare them to a comparable benchmark. (For example, a large-cap fund should be compared to a large-cap index.) It's also worth comparing funds to the overall performance of the stock market and the S&P 500. If the fund has historically generated returns that are in line with or better than the overall stock market — especially after fees are taken into account — that's a good sign. Stay away from funds that appear to underperform the market and their respective benchmarks.

Who Is the Custodian?

When employers set up 401K plans, they partner with a company that actually manages the plans and many of the investments. Usually, it's with a brokerage firm such as Fidelity, Vanguard, or Charles Schwab.

The best 401K plans will be managed by companies who have the expertise and ability to offer quality investment options with low fees, easy online account access, and research. It is worth noting that these custodians manage not only the plans, but many of the mutual funds in them, and that is often viewed as a conflict of interest. If it seems like the custodian is favoring their own underperforming plan in favor of a better plan from another company, that's a bad sign.

Look for Institutional Class Shares

There are many high-quality mutual funds that are unavailable to average investors unless they can meet very high account minimums. But, investors can often access these funds through their 401K plans, because companies can guarantee a sizable combined investment from their employees. Mutual fund companies will often waive fees and other expenses if certain investment levels are met. These funds are often advertised as "institutional class," or "premium class," and usually it translates into very low-cost funds for the investor. Fidelity's 500 Index Fund Premium class, for instance, has an expense ratio of just .045%.

Is There a Self-Directed Option?

A typical 401K plan will allow investors to put their money in any of about a dozen mutual funds. But some will offer the ability for account holders to take a more active role, through self-directed brokerage accounts. This is a good option for those wishing to have more direct control over their investing, though evidence is mixed on whether this actually results in higher returns for the investor.

Is It Wrapped in an Annuity?

Many 401K plans have an annuity option, in which earnings are disbursed in the form of monthly payments. This is a nice option to have, as it ensures a steady stream of income in retirement. However, some plans are "wrapped" in an annuity contract that is often expensive and with minimal benefit to the investor.

How good is your 401K?

This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

8 Signs Your Retirement Is on Track

Tim Lemke — Thu, 28 Jul 2016 09:00:11 +0000

You feel like you're a diligent saver, and are doing all you can to ensure you have a comfortable retirement. But how do you know if you're doing things right? It's hard to predict how much money you'll need, and it seems impossible to know if you're on the right track when retirement is years or even decades away.

Thankfully, there are some easy ways to tell if your retirement planning is sound. If your portfolio has most or all of these characteristics, keep up the good work and don't fret!

1. Most of the Funds Are in Tax-Advantaged Accounts

When saving for retirement, it's important to place your money in accounts that shield you from paying unnecessary taxes. A 401K is a common plan offered by employers that allows you to contribute and invest in a variety of different mutual funds. Any money you contribute will be deducted from your taxable income. It's also possible to invest in a Roth IRA, which allows you to invest and avoid paying taxes on any gains. If all or most of your money is in these accounts, you'll be saving thousands of dollars and will have a much higher net return on your investments.

2. You've Been Contributing Heavily

It's hard to know exactly how much you should put into your retirement accounts, but "as much as you can" is usually good advice. If you're maxing out your allowable contributions to 401K or IRA plans (or both), you're probably doing quite well. For 401K plans, you can contribute up to $18,000 annually. IRA plans can accept $5,500 in contributions each year. Even if you're not maxing out these accounts, contributing enough to take advantage of your employer's match of 401K contributions is one good threshold to hit. As much as people like to talk about stock market gains helping them get rich, the truth is that your portfolio's value is helped a lot more by the amount you're contributing in the first place.

3. You've Seen Steady Growth Over Time

Take a look at your portfolio's performance on a line chart. Are you generally seeing an upward trend, without a lot of wild ups and downs? Does it seem like your savings is steadily growing over time, even during periods when the stock market is not doing well? A good retirement portfolio should generally be free of volatility, and see steady gains as time goes on.

4. Your Projections Look Good

No one knows how the stock market will perform in the future, but you can make some reasonable assumptions based on historical market returns. The S&P 500 has seen average annual growth of about 7% since 2006, and annual average gains are even higher the farther you go back. If your portfolio's performance has been in line with these annual averages, you're probably in good shape, as long as you're contributing a significant amount.

It may be possible to project how much money you'll have in retirement by taking the amount you have now, then adding your contributions and the annual average return through your retirement year.

5. Your Investments Are Focused on Growth

Unless you are close to retirement, your portfolio should be heavy on investments that promise growth over the long term. This means a big dose of stocks, rather than bonds or cash. Small cap and value stocks should be a driver of most retirement portfolios, as they often promise the most growth potential.

It's tempting to want to be conservative with your investments, because stocks can be risky, and no one likes to feel vulnerable to a bad day in the stock market. But building a large retirement next egg requires you to overcome your fears and recognize the positive historical returns of stocks.

6. Your Portfolio Is Well-Balanced

It's always a good exercise to examine your investments to see if you are too heavily invested in any one sector or asset class. Sometimes, your portfolio can get out of whack, and will require rebalancing of your assets. If you are working hard to keep your investments nicely balanced, you'll likely be shielded from any major swings in the market and should see solid growth over time. There is one caveat here, which is that buying and selling during rebalancing could have tax implications, so you'll want to weigh the costs and benefits each time you're considering it.

7. You're Not Paying Too Much in Fees

A robust retirement portfolio should probably contain some mutual funds and/or exchange traded funds (ETFs). But these investments often come with management fees, commissions, transaction fees and other costs. A typical investor pays about 1.5% in fees, according to Rebalance IRA. That could add up to thousands of dollars over time. To avoid losing money to fees, look for investments with very low expense ratios, and those that trade without a commission. Low-cost investments often outperform those with higher expense ratios anyway. So if the costs in your retirement portfolio are low, that's one more thing you're doing well.

8. You Haven't Spent Any of It

There may be times in your life when you'll be tempted to withdraw money from your retirement accounts to pay for other expenses. There's a cost to doing this; any money taken early from these accounts is subject to being taxed, and you'll have to pay a 10% early withdrawal penalty if you take money early from a 401K. And of course, on top of these penalties and taxes, you'll lose out on any future growth this money might have accrued. If you've been diligent about not touching your retirement savings early, you'll be in much better financial shape than if you had raided these funds.

How's your retirement looking?

This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Are You Wasting $68,000 on Gas?

Tim Lemke — Mon, 11 Apr 2016 09:30:25 +0000

Commuting to work can be a real hassle, but have you ever added up what it's costing you financially?

With gas prices on the low side right now, it's easy to lose sight of the cost of driving. But if you have a commute and choose to drive, you may be losing out on hundreds of dollars a year and potentially hundreds of thousands of dollars over the course of your working life.

How is that possible? Well, let's crunch some numbers.

According to the U.S. Census Bureau, the mean commuting distance in America is about 38 miles. There are some parts of the country where commuters travel much further, and some mega commuters are known to average more than 200 miles each day.

Let's assume you're an average person driving that average 38 miles to and from work each day. And let's also assume you're paying an average amount for gas, which is currently about $2 per gallon. If you drive a car that gets 30 miles per gallon, you're spending about $2.50 a day on gas, or about $12.50 a week. (See also: This Is How the High Cost of Cheap Gas Hurts You)

Assuming you may take a couple weeks off throughout the year from driving, this adds up to $625 annually.

That's a nice chunk of change, but it's not the end of the story.

Compound Interest Is Your Friend

Having an extra $625 in your pocket at the end of the year is great. But you could actually end up with a lot more, without doing a thing.

If you put that extra money away in a run-of-the-mill savings account with a 1% interest rate, that could be $631 by year's end. Okay, so just $6. No big deal. But extrapolate that out to 30 years and you end up with $842. And if you put in $625 every year during that period, it's a whopping $22,000, thanks in large part to interest compounding on itself.

Invest and Build True Wealth

So now we're at $22,000. That seems like a nice addition to the nest egg. But imagine tripling that total.

If you take $625 annually and place it in an index fund or another investment that mirrors the broader stock market, you can boost your savings significantly. Assuming a typical annual return of 7% from the S&P 500, you'll end up with nearly $68,000 at the end of 30 years.

That's $68,000 by not spending money on gas, even with prices as low as they are now. And that's just for an average commuter. Someone who drives 60 miles round trip for work could save $108,000 over 30 years. A long-distance commuter who goes 90 miles a day could save $163,000.

Total Commuting Costs

Keep in mind, too, that gas is not the only expenditure when you commute. The Citi ThankYou Commuter Index last year said the average American spent $2,600 a year commuting. This includes people who might pay for public transit, and also factors in the cost of repairs and depreciation on your car.

Using the same calculations as above, that $2,600 could turn into $3,504 over 30 years if placed in a savings account. And $2,600 placed annually in an index fund could turn into $281,000 within three decades.

Keep all of this in mind when figuring out how you'll get to work, what job to take, and whether you can get away with working from home or even being self-employed.

How much are you spending on a daily commute to work? Share with us in the comments!

This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

The Top 5 Index Funds to Own Now

Qiana Chavaia — Fri, 24 Apr 2015 11:00:07 +0000

Can you tolerate some market volatility? Is investing in passively-managed index funds still part of your diversification strategy? Hang in there if it is, because index funds are still a good choice.

If you're hot on the trail for index funds to invest in, here are the top five index funds to own right now.

1. Vanguard High Dividend Yield Index Fund Investor Shares (VHDYX)

Morningstar rating: 5 stars

This large capitalization fund was designed for investors seeking long-term growth and those who can withstand greater volatility. This is an income-focused fund that invests in large U.S. companies that tend to pay higher dividends. Some of its holdings include ExxonMobil, Proctor & Gamble, and JP Morgan Chase, to name a few.

2. Vanguard PRIMECAP Fund Investor Shares (VPMCX)

Morningstar rating: 5 stars

A long-term capital appreciation fund that invests in large and mid-cap companies with an emphasis on the technology and health care sectors. The fund follows a well-established investment strategy of dividing its portfolio amongst several fund managers for diversity of thought. Its holdings include Texas Instruments, Inc., Eli Lily & Co., FedEx Corp., and many others.

3. Vanguard PRIMECAP Core Fund (VPCCX)

Morningstar rating: 5 stars

The PRIMECAP Core Fund is very similar to its younger sibling, PRIMECAP Investor Shares. This is a large cap fund that invests using the investment strategies of multiple fund managers. The key difference is the fund has both value and growth perspectives. Some of its holdings include Texas Instruments, Inc., Eli Lily & Co., Google, and Johnson & Johnson.

4. Vanguard U.S. Value Fund (VUVLX)

Morningstar rating: 4 stars

This is a large to mid capitalization fund that remains vested in about 200 companies using a qualitative approach that seeks to identify undervalued stock. Due to its broad-market exposure, investors should expect greater volatility and therefore invest with a long-term investment horizon. Some of the fund's major players are Pfizer, Inc., AT&T, Chevron, ExxonMobil, and Wells Fargo & Co.

5. Vanguard Consumer Staples Index Admiral Shares (VCSAX)

Morningstar rating: 4 stars

This fund is comprised of U.S. consumer staples, such as Wal-Mart, Costco, Coca-Cola Co., and PepsiCo. As a result, the fund will realize volatility consistent with consumer behavior, and investors should expect greater fluctuations. This is a very high-risk investment and it's advisable that it is used to hedge an already well-balanced portfolio.

Are index funds part of your portfolio? Which?

This article is from Qiana Chavaia of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

3 Steps to Getting Started in the Stock Market With Index Funds

Julie Rains — Mon, 02 Sep 2013 10:24:29 +0000

You'll often hear that index funds are the best way for new investors to get started in the stock market. The advantages of putting your money into index funds include:

Easy-to-make investment decisions
Performance that closely matches the market
Relatively low fees

The concept of index investing is simple — purchase shares of index funds and forget about them because you prefer passive to active management of your portfolio. Real-life implementation requires a bit more attention but is still relatively easy. Here's how to get started. (See also: Begin Your Investing Career With Some Mutual Fund Basics)

1. Learn About Stock Indexes

When you hear people refer to an index, they are most likely referencing the S&P 500 (or Standard & Poor's 500), which are 500 stocks considered representative of the U.S. economy. An index fund contains shares of these 500 stocks. Occasionally stocks are dropped and others are added to reflect changes in the economy.

There are many other market indexes, too:

Wilshire 5000 Total Market, which covers 3,000 to 5,000 U.S. companies on major stock exchanges
Dow Jones Industrial Average (DJIA), consisting of 30 stocks of large companies
S&P MidCap 400, representing mid-sized companies
S&P SmallCap 600, consisting of small-cap companies
Russell 2000, representing small-cap companies
MSCI EAFE, consisting of stocks in developed countries of Europe, Australasia, and the Far East
MSCI Emerging Markets, consisting of stocks in countries with emerging markets

Note that each index and its performance are typically weighted based on market capitalization, which is the company's stock price multiplied by outstanding shares. So, higher valued stocks with more outstanding shares have greater representation or weight in the index than lower valued ones with the same (or fewer) shares.

2. Find and Buy Shares in an Index Fund

Look for a mutual fund screener that allows you to select "index" as a criteria. A great place to find such a tool is your broker's website, which may list index funds separately from actively managed ones. You may find index funds among selections of your employer's 401(k) plan or through a general Internet search of funds matching one of the indexes. (See also: A Guide to Online Brokers for Investing Newbies)

Consider opening more than one brokerage account to broaden your choices. For example, start an account with Vanguard or Schwab to access their selections of low-cost index funds.

There are many types of index funds from which to choose. Look for an all-market index or S&P index fund. For example, the following funds replicate broad market activity:

SVSPX: State Street Global Advisor S&P 500 Index Institutional Class (minimum investment of $10,000 or $100 for an IRA; annual report expense ratio of .18%)
PREIX: T. Rowe Price Equity Index 500 (minimum investment of $2,500 or $1,000 for an IRA; expense ratio of .29%)
FSTMX: Fidelity Spartan Total Market Index (minimum investment of $2,500 or $200 for an IRA; expense ratio of .10%)
VTSMX: Vanguard Total Stock Market Index Investor Shares (minimum investment of $3,000; expense ratio of .17%)
SWPPX: Schwab S&P 500 Index (minimum investment of $100; expense ratio of .09%)

Buy shares in an index fund through your online broker, 401(k) plan at work, or directly from the fund company. Just as you would evaluate any other mutual fund, scrutinize management fees along with purchase and redemption fees. Compare performance with its underlying index; the two should be closely related, although fees, trading costs, and other factors may make returns slightly different.

3. Develop a Diversified Portfolio of Index Funds

If you've purchased an index fund based on the S&P 500, then you've covered the domestic (or U.S.) large-cap segment of your portfolio. To create a portfolio using asset allocation principles, buy a few more index funds that represent other portions of the market, such as mid-caps, small-caps, and international stock funds. You might also consider buying bond funds. (See also: Asset Allocation Basics)

To find a mid-cap index fund, look for index funds that replicate the S&P Midcap 400. Similarly, find a small-cap fund based on the Russell 2000 or the S&P SmallCap 600. Your international index funds could follow the MCSI-EAFE and MCSI-Emerging Markets.

Through your search, you'll locate funds like these:

DISSX: Dreyfus Small Cap Stock Index (minimum investment of $2,500 or $750 for an IRA; expense ratio of .50%)
NSIDX: Northern Small Cap Index (minimum investment of $2,500 or $500 for an IRA; expense ratio of .15%)
SWISX: Schwab International Index (minimum investment of $100; expense ratio of .19%)
VIMSX: Vanguard Mid Cap Index (minimum investment of $3,000; expense ratio of .24%)
VEIEX: Vanguard Emerging Markets Stock Index Fund (minimum investment of $3,000; expense ratio of .33%)

Target-date, all-in-one, and/or balanced funds have been developed so that you don't have to buy multiple index funds to build a diversified portfolio. However, fees for these types of mutual funds may be higher than traditional index funds.

Index Alternatives

Many index-based mutual funds have ETF equivalents. They may also have enhanced versions, which seek higher returns through certain additions, exclusions, weighting methods, etc. As a result, the fund tends to be less in sync with its index. Plus, management fees are generally higher as these types of funds are actively managed. (See also: ETFs vs. Mutual Funds)

Index investing allows you to match returns of the market: your investment portfolio grows when markets rise, though it suffers when markets are down. Because it's a passive approach, you can spend less time making portfolio adjustments compared to a stock, ETF, or fund picking method. Just be sure to buy low-cost funds that closely match the underlying indexes you have chosen.

Disclosure: This article discusses possible methods of index investing and funds are referenced for general information purposes. Investors should conduct research and/or seek professional advice before investing.

Are you an index fund investor? Which index or indexes do you follow?

This article is from Julie Rains of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Why Index Funds Are the Best Choice for New Investors

Darren Wu — Fri, 16 Aug 2013 09:48:29 +0000

Are you looking to build long-term wealth, but are so new to the world of investing that you don't know where to begin? If so, I've got great news for you.

There aren't too many things in life that both save you more money and make you more money at the same time. Fortunately, a type of investment known as an index fund is one of them. (See also: Begin Your Investing Career Right With Some Mutual Fund Basics)

That's why index funds are one of the best long-term wealth-building tools ever made. So let's dig in to see exactly what they are, and — more importantly — how they save you money and make you money all at once.

But before we go further, let me explain some terms.

What Are Mutual Funds?

In a nutshell, mutual funds are a basket of different kinds of investments. And the most common investments are stocks and bonds.

For instance, one mutual fund could be made up of a few hundred stocks. Another could be made up of a few hundred bonds.

This large amount of stocks or bonds is a good thing because it protects you. If a few stocks or bonds don't perform well, then there are still hundreds of others to help pick up the slack.

Different Kinds of Funds

Within the world of mutual funds, there are two types of funds:

Actively managed funds
Index funds

What's the difference?

Actively managed funds are run by managers who try — note the keyword try — to beat the market's return. So if the stock market goes up 8% one year, this manager will try to pick certain stocks so that you'll earn more than 8%.

Index funds, however, do not try to beat the market. All they do is copy it. So if the market goes up 8% one year, this fund has the same stocks that'll provide pretty much the same 8% growth. (See also: 7 Great Investments for First-Timers)

OK, now that I've explained that, let's go back to the topic of saving you more money.

Saving You More Money

First, it's important to know that all mutual funds come with a cost. The difference, however, lies in the amount.

Actively managed funds charge more for the "potential" for higher returns that I mentioned above. In some cases, a lot more.

According to a report from the Investment Company Institute (PDF), the average actively managed fund costs 0.92% a year. This means that for every $1,000 your investment is worth, you'll pay $9.20.

With index funds, however, you'll pay much less. The average index fund costs 0.13% a year. So for every $1,000 your investment is worth, you'll pay just $1.30.

Now, this $7.90 difference may not seem like a big deal, but that's because we just started with a small amount as an example. To build real wealth, you need to invest often.

Let's say you invest $5,000 every year for the next 20 years. Also, let's assume that both the actively managed and index funds grow by 8% per year (although I'll show you later that this isn't a fair assumption).

If you chose the actively managed fund, at the end of the 20 years you'd end up with $219,728 — a decent amount. But if you invested in the lower-cost index fund, you'd have grown your money to the sum of $242,994 — a difference of over $23,000. (See also: Boost Your Retirement Savings: Avoid 401(k) Fees)

What would you do with an extra $23,000?

Or here's another way to put it — how much would it hurt to lose $23,000?

This extra money that you'd make with an index fund comes from one thing, and one thing only — the cost savings.

So one way that index funds both save you more money and make you more money — at the same time — is by the simple fact that they cost much less.

But that's not the end of the story. There's another way index funds make you more money, and that's from the poor performance of most actively managed funds.

Making You More Money

A study from the S&P Dow Jones Indices found that during the past three years, over 86% of large-cap funds failed to beat their benchmark index, the S&P 500 index. While the actively managed funds provided just under 9% growth, the S&P 500 index grew by over 10% during this time.

This means that if you invested in the S&P 500 (through an index fund, of course) during this time, you would've made more money than 86% of all other related funds.

When you combine the greater long-term performance with the lower cost of index funds, you end up saving more money and making more money. (See also: Using Time Horizons to Make Smarter Investments)

If you'd like to see how I'm using index funds to build wealth, and how you can do it too, check out the Core Four Portfolio.

Do you invest in an actively managed fund or an index fund?

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This article is from Darren Wu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: