Many financial experts agree that the road to wealth through investments is a long one. Wealth accumulation is marked by regular contributions toward long-term holdings. Taking advantage of tax-deferred retirement accounts increases the compounding of your investment profits and maximizes your total portfolio growth. Diversification and asset allocation increase the relative safety of your portfolio over putting all your money in one type of investment. You can use mutual funds to achieve all this.
Tax-Deferred Retirement Accounts
Take advantage of your company's 401(k) plan and contribute as much as possible if your company has a policy of matching employee contributions. Consider starting your own tax-deferred retirement account to maximize your tax savings. Using these account types shields your investment earnings from income tax liability until you start withdrawing the money after retirement. Most employer-sponsored 401(k) plans are administered by mutual fund companies, and they present you with a selection of appropriate funds from which to choose. Mutual funds are also common investments for self-directed retirement accounts. For the average person with little investment experience, a mutual fund provides expert investment management and portfolio diversification.
Building wealth involves protecting what you already have. One way to accomplish this is to diversify your investments over as many different stocks in as many different industries as possible; you should also keep a portion in bonds and alternative investments, such as currencies and real estate. Complete diversification of a self-managed portfolio is nearly impossible for investors who are not wealthy. Mutual funds solve this problem, because they pool many different securities, providing immediate diversification. If one stock performs poorly, it represents only a small fraction of your entire holding, and its poor performance is usually offset by good performance in one of the other stocks.
Using different types of mutual funds allows you to modify the risk of your investments to match your personal risk tolerance. When you are under the age of 50, you still have enough years to make up for any losses you suffered with risky investments, so allocating more of your investment money to aggressive growth funds might create greater profits. As you approach your retirement, however, allocating the majority of your assets to conservative income-producing bond funds and dividend stock funds protects you from large losses if the market unexpectedly drops.
Mutual funds allow you to make regular small contributions with which you buy additional shares of the fund, so your money goes to work for you immediately. You don't have to wait to save enough money to buy a minimum number of shares of stock through a broker. Over time, small regular contributions buy fund shares during both bull and bear markets. This results in averaging the cost of your portfolio so your cost basis over time will always be lower than the historically highest price. Incremental contributions over time are a way to painlessly accumulate a significant investment portfolio.
Although mutual funds provide many benefits as investments, some funds have high fees that affect your total return on your investment, and other funds have poor performance records. Before purchasing, compare the fee structures of similar funds as well as their performance records over the previous five years. If the fund's performance has been good, check to see if the portfolio manager who produced those returns is still managing the fund portfolio. Not all mutual funds are smart investments, so it is important to research your choices.
- Jupiterimages/BananaStock/Getty Images