Accessing Your 401K

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401k IRS limits

What is a Mutual Fund?

A mutual fund is an investment company that pools money from individuals, institutions and other investors and invests the money in a variety of stocks, bonds and/or other investments. A mutual fund is an easy way for an individual to invest a relatively small amount of money and still be diversified if the mutual fund holds many different investments.

Why Mutual Funds?

Mutual funds do not require large up-front investments as do stocks. Without a significant amount of money, it would not be easy to assemble a well-diversified portfolio in individual stocks and bonds. However, you can easily assemble a portfolio of mutual funds to diversify your risk.

What About the Risks?

Stock Mutual funds are not insured or guaranteed. They can lose money because their value will always depend on the value of the individual holdings in it. You should expect that the market value of any stock or bond mutual fund to go up or down in value on any given day. You could lose a large percentage of your money that is invested in a mutual fund.

In addition, taxes and expenses can stand in the way of getting the best possible return. For that reason, before buying any fund, it is important to assess how much it costs: expense ratio, management fees, front and back loads, redemption fees and so on. Basic research can reveal which funds are more cost effective and consistently perform well.

There are two basic kinds of mutual funds: "actively managed" funds and "index" funds. Actively managed funds have an individual or team of people who make decisions as to what to buy and sell, and they decide when to buy and sell. No one will always make the right decision. Therefore, you can reasonably expect that in any given year, an actively managed fund will under-perform the "market". On the other hand, "index" funds are designed to track a particular stock market index. No one is making decisions as to what to buy or when to buy. The manager simply invests the money to closely match the particular index that it is designed to track. Actively managed funds, theoretically, give you an opportunity to out-perform the "market". Index funds won't beat its respective index, but you do not have the risk of a money manager making bad investments.

Why Mutual Funds?

Mutual funds do not require large up-front investments as do stocks. Without a significant amount of money, it would not be easy to assemble a well-diversified portfolio in individual stocks and bonds. However, you can easily assemble a portfolio of mutual funds to diversify your risk.

Using the Morningstar Style Box™

The Morningstar Style Box™ can help you classify mutual funds and construct a diversified, style-controlled portfolio based on the style characteristics of the funds in the recommended list. The Morningstar Style Box™ is a nine-square grid that classifies securities, such as mutual funds, by size along the vertical axis and by value and growth characteristics along the horizontal axis. Different investment styles often have different levels of risk and lead to differences in returns. Generally, funds leaning towards small or growth styles involve more risk and have a higher potential of delivering substantial returns (or losses). On the other hand, funds leaning towards large and value styles involve less risk and are expected to deliver smaller returns (or losses).

Mutual Funds Styles

Market capitalization is used to determine the size of the fund. Market capitalization is the evaluation of a company's worth calculated by multiplying the price of its share on the stock exchange by the number of shares issued. A large cap fund is a fund which contains stocks, each with a market capitalization of over $5 billion; mid cap funds contain stocks, each with a market capitalization of between $1 and $5 billion dollars; small cap funds contain stocks, each with market capitalization of between $250 million and $1 billion.

Growth-Value

In general, a growth-oriented fund will invest in companies that the fund manager believes will increase faster than the rest of the market. A value-oriented fund contains mostly stocks the manager thinks are currently undervalued in price and will eventually see their worth recognized by the market. A blend fund might be a combination of growth stocks and value stocks, or it may contain stocks that have characteristics of both. Index Fund

An index fund is a mutual fund that invests in the same securities as a stock exchange index. An index fund is usually preferred by investors who do not wish to rely on a fund manager's ability to out perform market indices. Bond Fund

A bond mutual fund is a fund whose investment objective is to provide stable income with minimal capital risk. It invests in government, corporate or municipal bonds which pay a predetermined, regular rate of return until it matures. Bond funds will go up and down in value but normally the volatility is not as great as stock mutual funds. Money Market Fund

A money market account is essentially a savings account with generally a higher interest rate than a regular savings account. The money market account in this plan is not insured, but is the safest fund if you do not want to risk any capital.

Investment Strategies

The following are different general strategies that can serve as guidelines to choose the mutual funds for your portfolio. Before choosing any of these strategies, you should take into consideration your personal circumstances, goals, and the level of risk you are willing to take.

Use only Money Market accounts, CD's, or savings accounts. Money Market accounts can lose money but they never have. Yields (i.e.. interest rates) are very low but this will offer you the most security on your principal. Use Money Market, Bond Funds or individual bonds. Bond funds can and have lost money. They go up and down in value, but generally not nearly as much as stocks. If interest rates go up, then the value of bond funds generally goes down. Conversely, if interest rates go down, then the value of bond funds generally goes up. Rate of returns in bond mutual funds are normally significantly less than stock mutual funds. However, generally, when the stock market does badly, bonds do well or not nearly as bad. Keep in mind that bond mutual funds CAN go down in value. Individual bonds can be held to maturity; whereas, bond funds cannot. We prefer individual funds to bond mutual funds. Put some money in Money Market funds, bond mutual funds, or individual mutual funds and put the balance in stock mutual funds. Typically you would put 40-50% in bonds and/or money market and the balance in the stock funds. The more in stock funds, then the more aggressive. The stock mutual funds should be in the "large-cap" funds and/or index funds. ) Put 100% of your money in stock mutual funds, mainly in the "large-cap" and "mid-cap" funds, including the use of the index funds. Generally, the more you have in mid-cap funds, the more aggressive you are. Put 100% of your money in stock mutual funds. A large percentage of your money will be in the small-cap and mid-cap funds and the international fund, if any. Very little, if any, of your money will be in the large-cap funds.

General Recommendations

• If your level of risk is 3 - 5, then try to use several of the mutual funds in the various investment groups. For example, if your risk level is " 4 " then you might have a Large Blend fund, a Mid-Cap Growth fund, a Mid-Cap Blend fund, and an Index fund. You might even have more than one fund in a given group if available. It is perfectly all right to have 5 or more funds in your portfolio.
• If you are using the bond funds, then you probably should use more than one of the funds that are offered.
• Don't try to "time" the market. It is impossible to consistently predict market tops and bottoms. You should make your decision to be in the market or not, and stick with that decision until your circumstances (not the market) change.

Criteria for Selecting Mutual Funds

Most firms that produce lists of top performing funds use performance that has been averaged over a period of time (i.e. 3 year average, 5 year average, or 10 year average). This analysis, although valuable, is limited and will not always select consistent performers. Consider the following example: Fund "X" has a 5-year average return of 20%, which looks good. However, it tells nothing about the fund's consistency. The fund might have had one year in which it returned 100%, yet earned nothing the other 4 years, and still have a 20% 5-year average return. Fund "X" did not perform consistently over that five years.

It is important to analyze the annual performance for each fund in relation to other funds with the same investment style. In addition, mutual-fund ratings, tenure, fees, costs, style, diversification, and other considerations should be analyzed to find the funds that have consistently performed well.

It is extremely difficult to find mutual funds that consistently outperform their peers. The top performing funds this year can easily be some of the worst performing funds next year.

Some funds have "transaction fees" that are charged by the institution when the fund is purchased. It is not cost effective to purchase small amounts of mutual funds when transaction fees apply. Also, some funds have redemption fees, so it is important to be aware of the funds that have these fees.

You should research the funds that you intend to invest in and/or seek professional advice as to which funds are appropriate for you and your situation.

Which Mutual Funds Should You Use?

Once you have determined a list of mutual funds that are consistent performing funds, or you are choosing from a list of funds offered through your 401K plan, you need to decide how many funds to use. If you have decided to use only index mutual funds, then it is perfectly fine to use only one fund; however, you should probably choose either a total stock market index fund or some fund that mirrors the S&P 500 Index.

If you decide to use actively managed mutual funds, then you should consider choosing at least 4 and preferably 5 or more funds. Many advisors say this is over-diversification, and will argue that there is most likely overlap between the funds as to specific holdings. However, there is "manager risk" when using actively managed mutual funds. This means that the individual or individuals managing the fund make have a bad year. If you split your money between two actively managed funds and one has a bad year, then half your money has a bad year. On the other hand, if you invest in 5 mutual funds, and one has a bad year, only 20% of your money has a bad year. Therefore, you should invest in 5 or more funds if you invest in actively managed mutual funds, and if at all possible, choose funds from different mutual fund companies, as each fund company will have an overall corporate investment philosophy that will transcend across all the funds they manage.

You should monitor each actively managed fund on a semi-annual basis, at a minimum, to make sure the fund is performing well. You should invest in index funds if you are unwilling to do this.