Understanding the mechanics of your employer-sponsored retirement account will help you be informed about how you are growing your money. While managing your plan may seem complicated, there are some basic principles you can learn that will elevate you from smart to savvy in no time. Expense Ratio:
The expense ratio is a measure of what mutual funds and exchange-traded funds charge shareholders to offset the fund’s annual operating expenses and is expressed as a percentage of the fund’s average net assets. Expense ratios vary widely based on the investment category, investment strategy and the size of the fund, with smaller funds tending toward higher expense ratios. You can compare the expense ratio of funds by looking at the fund’s prospectus, financial news websites, fund screeners and news journals.
Type of Investment:
The two categories of stock mutual funds are growth funds and income funds. While both types focus on maximizing returns, their strategies are vastly different.
Growth Funds offer the potential for higher returns with higher risks; they often perform in tandem with the overall stock market and do better when stock prices are rising, and can suffer when stock prices fall. These funds are comprised of shares in companies that focus on expansion and increased market share, and are best suited for higher risk tolerance and a longer time horizon. Netflix and Amazon are two good examples.
Income funds, by comparison, are relatively conservative investment vehicles. Income stocks pay dividends that can be reinvested to turbocharge the growth of a retirement account. Income stocks tend to be shares in well-established companies in mature industries. Think Proctor & Gamble or Apple.
When considering funds for your 401k or other retirement account, the life of the fund can be an indicator on how much to allocate to a particular fund. Newer funds carry more risk, as they may not have experience with market fluctuation, but they also carry the possibility of higher returns. Conversely, older, more established funds can sometimes weather the storm of a poor market more easily than their youthful counterparts.