While educating yourself on retirement investing strategies, these two terms likely come up often. And there are key reasons why. Keep reading to learn more.
What is a mutual fund?
A mutual fund is an investment opportunity allowing you to pool your money with that of other investors to purchase stocks, bonds, and other securities that you could not afford to invest in alone.
The higher your income, the more likely you’re investing in mutual funds: 84 percent of mutual funds are owned by the richest 10 percent — a fact that speaks volumes about the financial possibilities of mutual funds.
What is a 401(k)?
A 401(k) is an employer-sponsored, tax-deferred retirement plan. The employer chooses the 401(k)’s investment portfolio, which often includes mutual funds. But a mutual fund is not a 401(k).
What about taxes?
401(k) plans are usually tax deferred, meaning contributions are taken from your pretax income. Taxes are only applied when money is withdrawn from the account, typically during retirement when you are likely in a lower tax bracket.
Mutual funds, in contrast, are generally purchased with after-tax dollars. Income from the fund, including dividends and interest, 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 or contributes to your 401(k). If you don’t take advantage of that match, you are basically throwing away 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 can purchase, making mutual funds an effective way to diversify your retirement portfolio.
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.