Mutual FundsHow they work: Funds can be made up of a variety of underlying assets including stocks, fixed income, currencies, commodities and cash as well as a combination of these, depending on the style you choose.
A new breed of "retirement-income funds" is geared to nonworking seniors who want their assets to last for a specific number of years and keep up with inflation. For example, Fidelity Investments' Income Replacement funds provide individuals with monthly payouts that are geared, but not guaranteed, to keep up with inflation while untapped assets remain under professional management. The goal of Vanguard's line of Managed Payout funds is to help seniors strike a balance between generating capital growth and providing lifetime income. Schwab also recently announced new offerings.
Cost: Mutual fund prices and ongoing expenses vary. Actively managed funds are almost always more expensive than index funds. For example, actively managed value funds typically have expenses of 1.33 percent – nearly twice the average expense ratio of 0.68 percent for indexed value funds, according to Lipper.
Liquidity: If you own load funds, you may trigger front-end, back-end, deferred or other redemption fees when you sell. A short-term redemption fee, for example, is imposed on individuals who sell their fund shares within a certain amount of time, typically 30 to 60 days. Certified Financial Planner Brett Horowitz, a principal at Evensky & Katz Wealth Management, recommends individuals pick no-load funds, which are cheaper to trade.
Pros: Mutual funds are diversified and run by professional managers, eliminating worry for individuals who don't have the time, expertise or desire to manage their investments themselves. This is particularly true with so-called target-date funds that automatically readjust holdings to become more conservative as someone approaches retirement.
Mutual funds invested in equities have the potential to keep pace with or surpass inflation, depending on their underlying assets and performance.
Cons: Expense. Ongoing management fees can make mutual funds pricy to trade, though some index funds run very cheap. Generally, fees eat into investors' profits since they're deducted from fund assets.
Actively managed funds with high turnover may generate high taxes.
Risk: Capital depreciation. Mutual funds come with no guarantees and may lose money, depending on the performance of their assets.
Who they're good for: Funds are designed to achieve many different goals. For seniors looking for inflation protection or additional income, a mutual fund can provide more diversity for their investment dollar than purchasing, say, a single TIPS or dividend-yielding stock. Seniors who plan on a long retirement and who need to generate money after they leave the workforce, on the other hand, may also want to consider equity-based funds designed for growth. Any decision should be based on individual needs, risk tolerance and financial goals.