Have you ever felt hesitant to ask your investment advisor (or anyone else, for that matter) a question about investing or retirement planning? When it comes to these complicated topics, there are truly no stupid — or overly simple — questions. Though you might feel embarrassed asking a question if you think you “should” already know the answer, you’re better off getting the information than continuing to live in the dark about something so important and personal. After all, it’s your money … don’t you want to be confident about what you’re doing with it?
We get questions every day from people who admit to being embarrassed about their perceived lack of knowledge. Let’s tackle some of them here.
1. What is a mutual fund?
A mutual fund is a “basket” of investments, usually stocks and/or bonds. When all of the investments are bundled together into a fund, investors can purchase shares in the mutual fund. Having mutual fund shares means an investor owns part of the investment basket — regardless of which underlying investments are bought or sold. Mutual funds are often preferable to single stocks and/or bonds because of their diversification (the practice of purchasing a wider variety of investments to lessen a portfolio’s overall risk), convenience and lower costs.
2. If my mutual fund is losing money, should I stop investing in it?
Thanks to the nonstop news cycle, we can see what’s happening with the market on a minute-by-minute basis. However, always knowing what’s going on with the market or your specific investments isn’t necessarily a good thing. At Financial Engines, we emphasize a sound, long-term investing strategy over knee-jerk reactions to short-term market performance. This means that if you’ve done your research and thoroughly assessed the fund and its fit with your portfolio, it’s probably worth sticking with the investment even if it’s losing money in the short term. But, if you’re losing money from a mutual fund you picked randomly, you might want to look at other options.
At least annually, you should revisit your investment goals and re-evaluate the level of risk you’re comfortable with. You should also do this whenever you experience a major life event, such as marriage or the birth of a child, that may affect your retirement and investing goals (and your choice of investments as a result).
3. What is a bond?
Bonds are commonly referred to as fixed-income securities. They’re often used by investors to help diversify a portfolio and manage its risk. A stock is an ownership share in a company, whereas a bond (or debt obligation) is a claim on the assets of a company. There is generally less risk in owning bonds than in owning stocks. Bonds tend to provide a higher and steadier income than a money market or savings account; however, stocks have historically seen higher returns over longer periods.
4. What is an index fund?
An index fund is a type of mutual fund that matches or tracks the components of a market index, like the S&P 500 Index or Dow Jones Industrial Average. It can provide exposure to a large number of companies within a specific market segment. Typically, index funds have low management fees and returns similar to those of the indices they track. The term “index investing” is often used interchangeably with “passive investing.” With index investing, if the index rises 10%, the fund value should grow about 10%; if the index falls 10%; the fund should drop around 10%.
5. What is an expense ratio?
An expense ratio is a measure of what it costs a fund company to manage a mutual fund. Each mutual fund will have its own expense ratio shown as a percentage of the fund’s assets. On an individual investor level, the expense ratio is a fee for management costs paid for out of your investment in the fund. Higher expenses matter because they will reduce your returns.
Expense ratio = Total expenses to run the mutual fund / Total dollars under management
When you look at the total returns of a mutual fund, those numbers are always net of all expenses — in other words, they reflect performance after all fees have been taken out.
6. When I retire, is there a minimum amount I am obliged to withdraw from my retirement accounts per year?
A Required Minimum Distribution (RMD) is the minimum amount anyone over the age of 70½ is required to withdraw annually from their retirement accounts. For employer-sponsored retirement plans, such as 401(k)s and 403(b)s, RMDs can sometimes (depending on plan rules) be delayed until you retire. For traditional Individual Retirement Accounts (IRAs), you must begin taking RMDs once you turn 70½, regardless of whether you’re still working. However, RMD rules don’t apply to Roth IRAs while the account owner is alive.
Your plan custodian or administrator can usually help calculate your RMD, but it’s ultimately up to you to ensure that you withdraw the correct amount each year by the deadline (typically Dec. 31) — otherwise, the amount not withdrawn is taxed at 50%. The U.S. Securities and Exchange Commission offers a calculator at Investor.gov you can use to help calculate your RMD or contact an investment advisor for assistance.