I have heard similar versions of this question numerous times throughout my career. I imagine that the question posed in by This question has been posed to me numerous times throughout my career, in various ways. I imagine that seeing this blog title cause a number of readers to wonder “does she know what she is talking about?” while others thought “good question!
The frequency with which I have heard this question tells me is that the financial media and institutions are doing a poor job of explaining investment options to the average person. The question asked about is built upon a false premise that IRAs and mutual funds are comparable items.
If we were shopping and I asked you “Should I buy the blouse or the red?” chances are you would look at me strangely. Your response may be “You can buy the red blouse. Or you can buy the blue pants. Red and blouse are not mutually exclusive. First you decide if you want a blouse and then you choose the color.”
My answer to the Mutual Fund v. IRA question is exactly the same.
What is a mutual fund?
A mutual fund is an investment vehicle. Investopedia.com defines a Mutual Fund as “a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets.” In other words, a mutual fund is a tool for an investor to put their money into a single investment product that is made up of lots of different products. The investors essentially pool their money together to buy a portfolio of investments more diversified than any of them could buy independently.
If that explanation makes your eyes glaze over, just know that a mutual fund is a way that you can invest money. Some other investment vehicles that you may be more familiar with are stocks, bonds, real estate, CDs, and savings accounts. Mutual funds were created to allow those with smaller amounts to invest to still own a variety of investments. When you think of a mutual fund think of it in that category. You put your money into an account and invest it in a mutual fund just like you may put your money in a brokerage account and invest it in a stock.
A mutual fund is a category or type of investment. So if you decide that you want to invest in a mutual fund you will need to take further steps to determine which fund or funds are suitable for you personally. This will be different for everyone.
What is an IRA?
An Individual Retirement Account or IRA is a type of account that is taxed in a very specific way. The rules regarding IRAs are defined by the IRS and are intended to encourage people to save for retirement by giving them tax advantages for doing so.
There are different types of IRAs and each type is taxed differently.
- Tax Free: Roth IRAs are tax free, meaning you do not pay tax on the earnings if you adhere to all of the IRS rules regarding the account.
- Tax Deferred: Traditional IRAs, SEP IRAs, and Simple IRAs are tax deferred accounts that allow you to delay paying the taxes until you withdraw the money (again, this is assuming specific conditions are met). Some of these tax deferred accounts may also allow you to take a tax deduction in the year in which you put the money in the account.
- You may have heard about other types of IRAs such as deductible, non-deductible, self directed, and spousal. These are actually just sub-types of the tax free of tax deferred IRA account types listed above.
Before contributing to (AKA putting money into) an IRA or other type of retirement account check with your accountant, tax advisor, or financial advisor to see which type of account is most appropriate for you.
Once your money is in an IRA you have many choices as to how you would like to invest it. You can have an IRA that invests in CDs, stocks, bonds, mutual funds, etc. Novice investors will find that nearly any investment option they are considering may be held within an IRA.
So, what is the answer to the question?
The answer is that you can invest your money in a mutual fund within an IRA. Or you can invest your money in a different investment outside of an IRA. Or you can invest in a different investment within an IRA or a mutual fund outside of an IRA.
Do you see where I’m going with this?
The true question here is not “do I invest in an IRA or a mutual fund?” the question is a broader “how should I invest my money?”
In making this decision you should first ask yourself what type of account you should set up. This will depend upon your reason for saving.
If you are looking to save for retirement, should you look into starting an individual retirement account like an IRA? Do you have a company retirement account 401(k) that you are eligible to contribute to? Are you an solopreneur or small business owner who may want to consider establishing a SEP or SIMPLE IRA?
If you are trying to establish an emergency fund or general savings for shorter term goals then a retirement account is generally inappropriate. In these situations you may find that a regular “taxable” account best meets your needs.
A taxable account is a term used to identify an account that does not receive special tax advantages and is not held to specific IRS regulations on the withdrawal of the money. Items in this category would include a savings or checking account at the bank, a general brokerage account, or a non-retirement mutual fund account at an investment company such as Schwab, Fidelity, Vanguard, or T. Rowe Price. (I am not endorsing any specific company, I am just listing some of the more well known companies as a frame of reference.)
So, step one is to determine the goals/purpose for you money and have use that information to determine the type of account you need. The next step is to decide how you want to invest that money. There are many factors to consider in how you should invest your money. You need to evaluate your goals, your time horizon, your level of comfort with risk, and you ability to withstand loss, among other considerations.
As I mentioned above, mutual funds are just one common method of investing. And within the category of mutual fund there are many types of investments, degrees of risk, and types of fees.
If you have access to a financial advisor that is a great place to start your investment journey. If you are thinking about hiring a professional check out by blog Advisors, Planners, and Brokers, oh my! for information on the different types of financial professionals you may considering working with. (Obviously you can also check out my website too to see what my practice is all about.)
If you are going it alone, you will want to do substantial research before investing your money to make sure you understand what you are investing in, what fees you are paying, any locked in time requirements, and the potential risk and reward.
Unfortunately, there is no clear choice or easy decision when it comes to investing. The decisions are very personal as are the numerous factors to consider. But, hopefully I have helped you to gain a clearer understanding on where to start and some of the basic elements involved in making these decisions.
This blog is for educational purposes only and the information above should not be considered investment advice or tax advice. Every person has a unique situation that requires personal attention prior to making any investment decisions.
Maura Madden is a registered investment adviser in the State of Washington. The Adviser may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Individualized responses to persons that involve either the effecting of transaction in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.