Types of Investments - Class 402

Let’s start with mutual funds as they are the most popular type of investments offered within 401(k) plans. So what exactly is a mutual fund? A mutual fund is a collection of stocks and/or bonds wrapped into one security. These securities trade once a day at the market’s close, not within the trading day. The primary benefit of this option is the diversification* offered to the investor instead of concentrating their assets in just one company. The fund manager must oversee which stocks and/or bonds are purchased in the fund and in what amounts to achieve the fund’s goals. Since the fund manager charges a fee for this service, we definitely want to keep an eye on these investment fees (also known as the expense ratio) to make sure they are reasonable. We would generally suggest taking into account the share class with the lowest investment fee offered when evaluating your mutual fund options. For more information on expense ratios, please reference Class 106 – Investment Fees.

A variation of a mutual fund is an exchange traded fund (ETF). Like a mutual fund, an ETF is a collection of investments such as stocks and/or bonds wrapped into a single security. These investments typically track a particular index, sector, region, etc. One of the primary differences between mutual funds and ETFs is that ETFs trade in a similar fashion as a stock so you can place trades throughout the trading day. However, ETFs typically operate differently within a 401(k) Plan. Since most 401(k) plans are valued daily, the ETF trades only occur once at the close of the trading day. Many plan sponsors are interested in the low fees associated with an ETF. Please note that many mutual funds offer the same or lower investment fees for the same or comparable investment strategy.

The next investment option we’ll review are collective investment trusts (CIT). CITs are also similar to mutual funds regarding their makeup of stock and/or bonds. However, one of the things that sets CITs apart is the fact that they are not registered with the U.S. Securities and Exchange Commission and are, therefore, less regulated. The benefit of this is that they can be less expensive to investors due to lower compliance-related costs. One of the drawbacks associated with CITs is their lack of transparency. Therefore, they can often be difficult to track as there is no ticker symbol associated with the investment and the information related to the CIT’s performance and investment composition may be challenging to locate and understand.

Insurance companies offer another type of investment option known as annuities. An annuity is an insurance product where the investor funds a contract with the intention of receiving a guaranteed fixed income stream in retirement. This income stream may be for a fixed period of time or for the rest of the investor’s life. This option can be attractive to someone who would like to accurately forecast their income in retirement. However, as some of the fees associated with these insurance products may not be seen as competitive, annuities have historically been a less popular investment option within retirement plans. Just 10% of 401(k) plans currently offer annuities to workers, according to the Plan Sponsor Council of America.¹

Finally, non-qualified assets such as real estate, artwork, and other physical assets can also be included as investment options within a retirement plan. However, these options can be difficult to value over time as the asset’s worth can often be based solely on how much a buyer is willing to pay for the asset. This is one of the primary reasons non-qualified assets are generally not recommended as an investment within a retirement plan.

As mutual funds are the most popular type of investment option offered within defined contribution retirement plans today, we will be using these securities as the basis of our conversation for our senior year focused on 401(k) investment options. Join us for next week’s class when we discuss the first steps in building the fund line-up for your retirement plan…
 
¹ "More People May Soon Have Annuities in Their 401(k) Plans" by Greg Iacurci. CNBC, JAN 3 2020

Diversification does not guarantee a profit or protect against a loss. Financial planning and investment advisory services provided through Sentinel Pension Advisors, Inc., a SEC-registered investment advisor.