Good news, the IRS has raised the 401K plan limits for 2013.

The 2013 maximum 401K Contribution

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Back in my college days I had several friends that seemed to have access to all the money in the world as they went to school. One friend in particular spent all kinds of money on off roading vehicles and modifications, and that was just one of his expensive hobbies. I was a bit jealous to see him and all the amazing things he purchased and did. Contrast that with my lifestyle of working as many hours a week as I could while going to school full time so I could avoid any debt. I had no idea what a trust fund was at the time, but my friend was a perfect example of a trust fund baby. He had an education trust fund set up as well as some other interesting trust fund stuff going on in his life while I was living off my Ramen Noodles and minimal sleep as I tried to make it through college.

So What is a Trust Fund?

The question of what is a trust fund is one that a lot of people have asked over the years. Generally speaking, a trust fund is something that people associate with the rich or the famous, and particularly with the children of the rich and famous. However, a trust fund is just a financial tool; nothing more and nothing less. Once someone actually investigates how they work, they’re actually quite simple to comprehend.

A trust fund is a method of controlling and administering assets for the benefit of someone who cannot do it for themselves. Often this includes young people and children (hence the derogatory term “trust fund baby”), but it can also include older people who many no longer have the capacity to manage their own funds.

The process begins when the originator, or the original donor, provides the funds for the trust to be started up. Trust fund managers then take over the fund, investing it and growing it so that it becomes even larger. The beneficiary, the person the trust was created for, will be given a certain amount of money from the fund on regular dates to provide for his or her needs. The beneficiary must comply with the rules of the trust fund in order to keep receiving funds, however.

Types of Trust Funds

There are two major kinds of trust funds, and mechanically they’re very similar to one another. The first is called a living trust, and it is created for a beneficiary while the creator is still alive. This is often the sort of fund created for younger children that need to be taken care of, but which cannot be trusted with their own funds just yet. Similarly, these trusts can be created to provide care for older relatives to put them on a steady income. These trusts can be changed, and even dissolved, as long as the person who created it remains alive and maintains power over the trust and its funds.

The second kind of trust is called a testamentary trust, and it is provided through someone’s last will and testament. This kind of trust is permanent, in the sense that the creator can’t cut it off since that individual is already dead. Beneficiaries named will have access to the funds as per the agreement and rules that created it.

Why Create a Trust Fund?

While it might seem like a convenient way to provide help to family members, a trust fund is a tool that comes with a variety of different uses. For instance, many times the funds that go into a trust can avoid being taxed. This is true for funds that would be subject to an inheritance tax, income tax or any other kind of tax. Though taxes will have to be paid when the beneficiary gains access to them, the taxes will be deferred.

Additionally, a trust fund might be created to benefit a certain group of people, an organization or some other collection entirely. So, for individuals who believe strongly in leaving money to a cause, but who want to do it in a way that isn’t just a lump sum payment, a trust fund is one of the solutions to that particular problem.

I don’t hold anything against my friend the trust fund baby, I wish I had an education trust fund set up for me or any type of trust fund for that matter would have been pretty cool.

So how many of you out there living off a trust fund? My guess is none of you, since most people in those types of situations are not the people reading about personal finance since the do not have as much of a need to, it is the rest of us that read this kind of stuff.

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I was talking with a friend and the question came up “how does the stock market work?” This got us talking about how the stock market and trading has evolved through the years.

The financial markets are a complex entity with their own institutional and economic structures that play a vital role in how stock prices are established. These structures also influence the stability and orderliness of the marketplace. The primary ways that these financial markets are organized include over-the-counter and floor stock trading. However, recent electronic facilities have greatly blurred these traditional distinctions and are changing how the stock market works.

When you purchase and own a stock, essentially you own part of that company. Each share you buy represents a small part of that ownership. When a person or business holds a greater number of shares, they own a larger percentage of the company. The objective for investors is obtaining bigger dividends as the company profits and stock shares increase in value.

The traditional method of stock trading occurs on an exchange floor in an open manner. On stock exchange floors, market trading is usually noisy and chaotic. These areas are filled with many investors who are shouting, gesturing and running around. Stock traders are frequently seen talking on phones, working on computer terminals and monitoring their consoles closely.

With electronic online market trading, investors use computer networks instead of trading on the market floor. Large networks of computers are utilized to match buyers and sellers conducting trades through an electronic marketplace. Although this technique isn’t perceived to be as exciting and bustling as a market exchange floor atmosphere, it is much faster and more effective. Computer trading has truly revolutionized how the stock market works.

If you are interested in stock market trading whether electronically or through conventional methods, the first step is getting an investment account through a broker. To begin traditional floor stock trading, an individual makes a request to the broker to purchase a certain amount of shares. After this request is made, the brokerage firm forwards your order to a floor clerk. The details are passed to another trader who sells the requested shares. The transaction finishes when a specified price is agreed upon. The investor is alerted after a final conclusion is confirmed. The process can take some time, based on several factors such as price fluctuation and current market movement.

Investing online is far less complicated and much faster. This is because computers and networks can match the selling and buying of stocks in real time. For investors that are savvy, they have the distinct benefit of instant and automatic trading updates live. Whether you are at home or at the office, as long as you have Internet access it is possible to quickly calculate which direction stocks are moving. Another advantage is having access to a variety of tracking tools. Many online brokerage firms offer these tools at no cost for their trading clients.

The emergence of electronic stock trading has decreased the necessity for physical exchanges. In fact, many conventional trading floors have been closing. The communication of executions and orders are mostly conducted electronically. Because of computers the NASDAQ and the London Stock Exchange are both completely electronic. Others have started phasing out floor trading, however some offer both electronic and floor transactions. Even on exchange floors, computer-generated electronic messages are frequently used. It’s not unusual for investors nowadays to buy and sell stocks through e-mail or instant messaging platforms.

In the simplest term on how the stock market works, it is facilitating the buying and selling of securities between investors. Just imagine the difficulty if you had to buy or sell shares on your own without this large marketplace. Participants meet and then decide on a mutual price of shares. We have all seen pictures of trading floors, in which people are signaling, yelling, waving and wildly moving their arms. This method is slowly giving in to virtual stock trading. Whichever your choice, it’s highly recommended to use an established and experienced brokerage firm to facilitate your trading activity. I use tradeking, but scottrade is good as well.

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Think about buying a new or used car. At the time, you may have the money to buy a new car and because of that think that buying is absolutely the best option. Five years down the road, your new car may only be worth two thousand dollars more than a comparable used one that you could have bought for $10,000 less than the new one. The short term joy of owning a new car can be a very bad long term investment.

Now, let’s look at investing in a house. If you are not planning to live in a house for a long period of time, it may be better to lease a place. Let’s say you go out and buy a small home for $220,000. Five years later you are married and planning to move to start a family. Unfortunately for you, the real estate business is slow and you can only get $150,000 for your house. Between that $70,000 you lost and all of the property taxes and interest you paid over the years, you may have $100,000 less to spend on the house that you want to raise your family in than you would have if you had been leasing a place for those five years.

One of the most underfunded investments today is a retirement fund. Someone who invests $2,000 per year in a retirement fund starting at age 25 will have about $500,000 in their account from deposits and earnings by the time they turn 65. Someone who invests the same amount per year at the same interest rate starting at age 35 will only have about $250,000 when they turn 65. The 25 year old is spending an extra $20,000 over a ten year period to earn an extra quarter of a million dollars. No matter what short term investments you make over those ten years with the 20 thousand dollars, it is very unlikely that you will earn near that much.

Thinking about investments from the long term point of view does not only apply to major purchases like a house or car, the concept applies to smaller things as well. Let’s say you are buying a new laptop. You can get a great laptop for $1400 that will last you an estimated seven years. You can also get an average laptop for $600 that will last you about three years. Overall, you are paying $200 per year to own a working laptop, no matter which one it is that you choose. The difference is that by investing for the long term, you will get to use a much better laptop for seven years than you would if you saved money for the short term.

Owning a car (or two or three) is one of the bigger financial decisions most people will make. While many wouldn’t consider a car an investment since they depreciate in value, owning a car still requires the use of money that could otherwise be invested. And it goes beyond just the purchase price of the car because you will have recurring insurance costs for the life of the vehicle. Most people choose one company to get their car insurance from and stick with it as long as their are no major problems. This means that people often use the same car insurance company for multiple cars that they own for decades of their life. Instead of using the car insurance you began with, you should look into other comparable policies that you may be able to get for much cheaper. It is not surprising for someone who does a little research to find out that they can save $500 per year on their car insurance policy by switching their coverage. Over the course of a driver’s lifetime, they may end up saving $20,000 or more by making sure they have the best policy. What would you invest that savings in? Make sure to visit cheapcarinsurance.net to check if you can find a better policy than the one you currently have. Saving a little money today can open up investment doors for the future.

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So, Kathryn from Kathryn’s Conversations has been kind enough to make a quick video that talks about your financial statements and what you should be looking for on a quarterly basis. When it comes to your retirement nest egg, you can never be too careful, and missing a few little details could end up costing you thousands. So, here are two of the most important things to look at on your next quarterly statement.

This is a guest video from Kathryn. Kathryn has twelve years of experience working in the hedge fund industry. She’s currently a Director at an asset management firm in Los Angeles. When Kathryn is not writing posts and producing videos for her blog, Kathryn’s Conversations, she’s thinking about what she’s going to write, and what videos she’s going to produce for her blog. 

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Market Orders

Market orders are the most common and easy to understand of the order types. A market order is simply an instruction to buy or sell the securities at the current market price. Unless you give different instructions, this is the type of order that will be placed. Market orders are almost always guaranteed to be executed as long as there are active buyers and sellers in the market.

One of the drawbacks of market orders is that the investor is at the mercy of the bid and ask spread. Buy orders are filled at the ask price, and sell orders are filled at the bid price. Depending on the individual stock and market activity, the bid and ask spread could be fairly significant. Another drawback is that in fast moving markets, you may receive a different price from what the current quote is.

Limit Orders

Limit orders do just as they say, and allow investors to set a limit on the buy or sell price. While market orders will be executed at whatever the market price is, a limit order won’t execute unless your limit is reached. Limit orders can be either buy or sell orders.

Buy limit orders are executed only when the price of the stock you want to buy is at, or lower than your limit price. For example, if you wish to purchase 10 shares of  XYZ stock at $20.15 and the ask price of the stock is currently at $20.20, your order will remain open. If the ask price never drops to $20.15 or lower throughout the trading session, your order will never be fulfilled. If the stock does move lower, and the ask jumps to $20.10, your order would be filled.

Sell limit orders work the same way, only in reverse. If you currently own 10 shares of XYZ stock and you want to sell the shares for $20.25, yet the stock’s bid price is $20.15, the order will not be filled and remain open. If at some point the bid price reaches $20.25 or higher, the order would be fulfilled.

The risk with limit orders is that the order may never be executed. If you wanted to buy a stock at a set price and it is on a run and rapidly increasing in price, your order wouldn’t be filled and by the time you could place another order, you may have missed out on substantial gains. The same goes for sell limit orders never being filled. If you wanted to unload a stock at a set price and it continues to fall, you can realize additional losses as the stock declines and your order goes unfilled.

Stop Orders

The stop order is generally used to protect profits or minimize further losses. A buy stop order is always placed at a price above the current market price, and a stop sell order is always placed below the current market price. When that stop price is reached, the order turns into a market order and will be executed at the current market price. For example, if you have a stock that you purchased at $20 that is now trading for $30, you can protect some of that profit by setting a stop sell order. You could place the stop at $25 so that if the price does fall to $25 or below, your order will be converted to a market order and executed.

The advantage of stop orders is that it makes it so an investor doesn’t need to monitor the stock market every second of the day. Investors can place various stop orders to protect gains and minimize losses without being around the computer.

The main disadvantage of stop orders is that you can get “stopped out” by a quick price movement that may not be warranted. A rumor or press release may send traders into a frenzy and briefly send the stock into your stop territory only to reverse course moments later when things settle down. Since stop orders turn into market orders when the trigger price is reached, you also have the possibility of executing the trade for a price that is different from the stop price.

Stop-Limit Orders

Like a regular stop order, investors use these orders to protect profits or minimize losses. The difference is that this order turns into a limit order when the stop price is reached, not a market order. This type of order gives you more control of when and at what price the order will be executed at. With this added control comes the possibility that the order may never be filled.

The reason this can happen is because if a stock is moving rapidly and hits your stop point, it may continue to move rapidly past your limit order, leaving the order unfilled. This could result in even further losses or losing some profit as the market moves past you. On the other hand, the stop-limit order can help you from getting stopped out early from a quick price movement that doesn’t hold.

Day Orders

All of the orders discussed so far are typically placed as day orders. This means that when you place an order, they are only good for the trading session that they are placed. So if you place an order at 10 a.m. and it doesn’t get filled before the market closes at 4 p.m., you’ll have to place another order the next day if you still want to make the trade.

Good ‘Til Canceled Orders

If you don’t want to worry about placing orders each day in the event they don’t get filled, you can place a good ’til canceled, or GTC order. These orders are good until executed or you decide to cancel it. This can mean an order could stay open for days or weeks. Even so, many brokerage companies have limits on how long GTC orders can be left open.

Other Order Types

There are a number of other order types, but the ones referenced above are the most common, and should be available to all brokerage platforms. The other order types are usually contingent on other factors, and may or may not be provided by your brokerage, so you will want to check before placing any trades.

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Eligibility for IRAs

When it comes to saving for retirement, most people will utilize one of the two most common individual retirement accounts — the traditional and Roth IRA. Without getting into a lesson on the differences between a traditional IRA and Roth IRA, we’re going to work with the most notable difference in that a traditional IRA is funded with pre-tax dollars and qualified withdrawals are taxed, and the Roth IRA is funded with after-tax dollars and qualified withdrawals are tax-free. Before you give up on your 401k you need to make sure you’re eligible for contributing to an IRA. After all, if you’re ineligible to receive the tax benefits that IRAs provide, even without a match it would make sense to keep contributing to your 401k. Lean More: How to roll over your 401k into an IRA

Roth IRA

Eligibility for a Roth IRA depends on your income. As a married couple you would qualify for a Roth IRA if your modified adjusted gross income (MAGI) is below $173,000. If MAGI is between $173,000 and $183,000, then you can contribute some, but not the full amount. If income exceeds $183,000, you do not qualify for any current year Roth IRA contributions. Single filers begin phasing out of a Roth IRA at $107,000 and is gone completely at $125,000. As you can see, depending on your income, giving up your 401k in favor of a Roth IRA may not even be an option. It’s a good idea to have a Roth IRA if you qualify, but just keep the income limits in mind before stopping your contributions with your current plan.

Traditional IRA

Here’s where things get a little more tricky. Unlike a Roth, a traditional IRA is funded with pre-tax dollars, so this type of retirement account closely matches your 401(k). If you were looking to mirror what you’re currently doing from a tax perspective, this is your likely candidate. That being said, the IRS doesn’t make it easy for us. There are also income limits and other considerations that need to be addressed before qualifying for tax-deductible contributions. The deductibility phase out for a traditional IRA for a single filer begins at $56,000 and ends at $66,000 if you’re currently covered under an employer-sponsored retirement plan. Joint filers phase out between $90,000 and $110,000. If married and your spouse is not covered by an employer plan, then there is no limit for you. I emphasized a piece of information above because there is often a lot of confusion as to what this means. Being covered by an employer-sponsored retirement plan has nothing to do with whether or not you’re contributing to a 401(k). Just because you elect not to doesn’t mean you’re not covered. As long as you have a plan and could contribute to it, as far as the IRS is concerned you’re still bound to the income limits. Furthermore, other pension and profit-sharing plans would also count. So even if your employer eliminated the 401(k) completely but still provided some sort of pension benefit, that’s considered being covered under an employer plan and subject to income limitations.

Other IRA Considerations

Finding out if you’re eligible for an IRA is the first step, so what’s the next step if you are? First, decide which type of IRA would be most beneficial for you. Are you single, no kids, and no major tax deductions? You may enjoy the continued benefits of deducting current contributions from your taxes with a traditional IRA. If you’re looking ahead to the future and expect your income to increase and tax rates to be higher, then a Roth IRA that gives you tax-free withdrawals in retirement may be your best bet. As long as you qualify, you could opt for an IRA of each type. To get started with your IRA, you have a few different options. First, you can open up an IRA with one of the big no-load fund companies such as Vanguard or Fidelity directly. Keep in mind that there may be a minimum investment requirement to get started. But this is a good way to invest directly in the low-cost funds you want.

The other option is to open your IRA with a discount brokerage company such as TradeKing. With a brokerage IRA you will have more flexibility in terms of investment options. Here you can buy individual stocks, bonds, ETFs, mutual funds, and even CDs all within the same account. If you’re looking to move beyond index funds with just one company, this can provide some flexibility as long as you keep transaction costs down, which  TradeKing will do. Finally, don’t overlook the reduced IRA annual contribution limits. In 2009 you’re only allowed $5,000 ($6,000 if age 50+) per year in IRA contributions. If are currently putting more than this amount into your 401(k) you’d want to make sure you’re still contributing as much as you can. For example, if you have been contributing $10,000 to your 401(k) and want to switch to an IRA, you should max out your IRA with $5,000 and reduce your 401(k) contribution to $5,000. This way you’re still adding your $10,000 to your retirement accounts each year, but it’s simply divided across two accounts.

Some Final Considerations

A 401(k) without a match is still a viable retirement account, although the deal is obviously not as sweet without the free match money. If you’re considering the switch, be sure you take into account all aspects of the plan. While 401(k) plans get discussed in the news about high fees, remember that not all plans are created equal. Obviously, if you’re in a plan with high fees and you do qualify for an IRA, the decision is pretty simple. But there are a number of plans that may also have even better fees than you can get no your own. For example, my 401(k) plan has institutional variants of funds, including some Vanguard and Fidelity. That means after all said and done, my net expenses are the same or even lower on these funds than I could get in my own IRA. So, if your company drops the company match and you’re trying to decide what to do:

• Examine your current plan, check expenses and fund offerings, and see if the match has been temporarily suspended or eliminated indefinitely.
• Check to see what type of IRA you qualify for, and if eligible, decide whether a traditional or Roth is better for your situation.
• Open the necessary IRA through a no-load fund company or discount brokerage such as TradeKing.
• Make sure you’re still contributing the same amount or more to your retirement accounts even if this means contributing to both an IRA and your 401(k). Just because your company stopped matching doesn’t mean you should contribute less overall.
• Prepare for changes to your tax situation. Going from a 401(k) to a Roth IRA could have an impact on your taxes, so plan accordingly.

I hope that helps clear things up when faced with this question. As you can see, there are many reasons to switch to an IRA if your company drops the match, some of which I didn’t even touch on here. But there are also a number of limitations that need to be taken into account before making that decision as well. There may not be a right or wrong answer to this question, but if you’re armed with all the facts, you can make sure you’re making the most reasonable decision for your situation.

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As part of the Roth IRA Movement started by Jeff Rose at Good Financial Cents, over 125 bloggers are using March 27th as the day to bring awareness to the Roth IRA, how they work, and some of the benefits. While there is a lot of information to cover regarding these accounts, I’m going to focus on the tax implications of converting a 401k or traditional IRA into a Roth IRA.

While it’s generally accepted that the Roth is going to be a better option for a lot of people in retirement you can’t discount the true cost of the conversion. In most cases, the argument is that many people will be in a lower tax bracket right now and at the time of the conversion compared to in retirement. This has to do with the fact that the government has a nasty habit of increasing taxes and that you may have accumulated a significant nest egg that generates even more income in retirement than you had before you retired. So, in this scenario it would make sense to have tax-free income in retirement rather than getting less of at tax break while you’re working.

Unfortunately, it’s not that simple.

Using Roth IRA Assets to Pay Conversion Taxes

There are two different ways you can handle the taxes when you do a Roth conversion. Ideally, you would have funds already set aside outside the IRA that you can use to pay the taxes. This means your account value remains intact and you only have to pay the prevailing tax rate on the conversion amount. There’s also another way, and that’s to use the funds inside your IRA to cover the tax bill. Sadly, this is what a lot of people are choosing to do simply because they don’t have the money available to pay the taxes on the conversion. Big mistake.

First of all, if you choose to do this you’re actually taking a distribution from your IRA. Now, if you’re under 59 1/2 when you do this you’ll be subject to the 10% early withdrawal penalty. So, not only are you owing the regular taxes, but you are getting hit with an additional 10% penalty. If you use outside funds to pay the taxes this penalty wouldn’t apply. Second, using IRA proceeds to cover the taxes just reduces your account value. You could easily be faced with the fact that your account will be cut by about 40% just to do the conversion. How long would it take to recover from that?

Running a Few Different Scenarios

One of the tools I have through work is Blackrock’s Roth IRA conversion calculator. With this tool you get to plug in a bunch of numbers to create different scenarios to tell you whether or not a Roth conversion is the best choice. For this exercise I wanted to focus on the impact that paying the taxes from the IRA assets has on the conversion. Obviously, there were many scenarios where having a very low tax rate now versus a very high tax rate in retirement showed the Roth was the big winner, but I wanted to focus on a few more realistic scenarios.

For these scenarios all of the data is the same except for the tax rates before and during retirement:

• 35 years old at the time of the conversion
• Begin taking retirement distributions at 62
• Planning for 30 years worth distributions
• 8% returns pre-retirement
• 5% returns in retirement
• $100,000 account value

Assumptions:

The results assume that the taxes due when converting your current account to a Roth IRA are taken from the assets being transferred. It also accounts for the early withdrawal penalty on assets used to meet that tax liability. You do have the option of paying the tax liability out-of-pocket, which would affect the results. It further assumes that taxpayers at any income level may convert to a Roth IRA and that any tax liability arising from the conversion is paid in equal installments over two years, beginning with the 2011 tax year, at the same tax rate. The two year tax rule does not apply to conversions made during 2012. It also assumes that no distributions are taken before age 59½ and that you take even annual distributions during the retirement period you specified.

Roth Conversion at 28% Tax Rate Before and During Retirement

For the first example I wanted to see what would happen if tax rates didn’t change between the date of the conversion through retirement. I stuck with a middle of the road tax rate of 28%. As you can see, when you take money out of the IRA to cover the taxes and penalty you are left with a much smaller nest egg upon retirement when compared to leaving it in a pre-tax account. In this case, it’s nearly a $300,000 difference. Of course, when you break it out into annual withdrawals the impact is minimized, but you’d still be better off in this case to not do a Roth IRA conversion.

Roth Conversion at 25% Tax Rate Before and 28% During Retirement

What happens when your tax rate is higher in retirement? This is the classic example of when a Roth is the perfect retirement vehicle. Well, again we can see that because taxes were paid out from the IRA the damage done is hard to recover from. Even in this scenario there is a case that can be made to show that the conversion might not be the best idea.

Roth Conversion at 28% Tax Rate Before and 33% During Retirement

As tax rates increase both before and after, the gap narrows. Sticking with the pre-tax account virtually identical with the Roth just slightly losing out. But in reality and with variations that can’t be planned for I’d call this scenario as virtually equal.

Roth Conversion at 33% Tax Rate Before and 25% During Retirement

What happens when you bet wrong completely? All of the previous examples were showing tax rates the same or higher in retirement. But we simply don’t know what will happen decades from now. So what happens if tax rates end up being lower, or you make less in retirement therefore have a lower tax rate? Ouch! Making the wrong bet and using IRA assets to pay the conversion taxes cost you almost 20% overall.

Some Final Considerations

First of all, there are a lot of assumptions being made when it comes to long-term financial planning. Even though these examples kept everything constant across the board except for tax rates the real world will throw things in that can’t be predicted here or anywhere. You may retire earlier, or later. You may not be able to get the returns you expected leading up to retirement. You may not get the returns you expect in retirement. Your tax rates may change numerous times between now and retirement. Laws regarding retirement plan distributions may change entirely. There are many things we simply can’t plan for, so you need to keep that in mind when trying to weigh your options. Even what appears to be the best decision on paper today may come back to bite you in 30 years. The best you can do is make an informed decision.

This exercise wasn’t to make an argument against a Roth IRA conversion. Not at all. It was simply done to show the significant impact that using your account proceeds to pay the tax bill can have on the end result. Paying the taxes with outside funds is a completely different situation and the results are very different. Instead, this just throws a little information out there for those who were thinking about doing the conversion after hearing all the hype in the news and maybe didn’t think about where the money for taxes was going to come from.

Finally, keep in mind that even if you do have outside funds to cover the tax bill you want to make sure you’re not putting yourself into financial harm. If it’s going to take every penny of your emergency fund to pay the taxes on a conversion you’re putting yourself in a risky short-term situation only to try and maximize something in the future. In addition, even if you do have enough cash on hand to pay the taxes it may still end up bumping you into a higher tax rate, could end up subjecting you to AMT, or any number of tax complications.

My recommendation is to simply not take the decision to convert to a Roth IRA lightly. Unless your account is very small or you’re only converting a portion of your total retirement portfolio you should seriously consider getting some professional advice. Either from an accountant who handles your taxes or a fee-only financial planner you trust. They can help you navigate the waters of this important decision.

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Like anything, this convenience comes at a cost. Whether you’re investing in an actively managed mutual fund or an index fund, it costs money to run these investments. Some funds charge up-front fees and recurring expenses, others charge a back-end fee, and some just charge a regular recurring fee. It can get confusing for a new investor but with a little help you can learn how to spot what type of fees you’ll be paying and how to minimize those fees. After all, the less you pay in fees the greater your overall returns will be.

Load vs. No-Load

A load is one of the most important fees to watch out for. A load just means it’s an expense in addition to the underlying fund expenses. Typically these come in the form of front-end loads, often sold my financial advisers or brokers who work on commission. You pay the load up-front when you purchase the shares. Loads can vary greatly between fund companies, how much money you’re investing, and more. But it isn’t uncommon to see equity funds with a front load as high as 5.75%. To put that into perspective, if you wanted to invest $10,000 in ABC fund with a 5.75% load, you’d immediately lose $575 to the front-load fee. Ouch! And that’s in addition to the recurring annual expenses that may run higher than 1%.

The good news is that you don’t have to use loaded funds. While nobody will stop you from purchasing shares in a fund with a front-load, you’re typically going to be presented these funds by someone in the financial industry who works on commission. That’s because most of that load is a salesperson’s commission. So if you think about it, it’s no wonder they might try to steer you to a fund with a high load since they are going to instantly put a few hundred bucks in their own pocket. So you have to ask yourself whether the advice they gave you was worth that fee. In most cases, probably not. A fee-only financial planner won’t steer you into loaded funds since they aren’t earning a commission based on how much money you invest and where, and instead earn money by charging you for the advice they provide.

What about if you’re investing on your own? Obviously, you want to stay far away from front-load funds if you’re investing on your own. There’s no need to throw money away to a one-time fee just for purchasing the fund. So, how do you spot funds with fees? Morningstar is my favorite tool for this task. It packages all of the important information on an easy to use page that highlights everything from return, fees, yield, and more. Here is an example of using Morningstar to pull a quote on the Franklin Income Fund (FKINX):

You can easily see the front load listed on the first page. This fund has a 4.25% front load. If you had typed in a no-load fund it would show 0.00%.

Stick to No-Load Funds

It’s probably quite obvious, but you should stick to no-load funds. There’s almost never a situation where it’s worth losing a few percentage points off each investment just by investing in a load fund. Not sure where to start with no-load funds? While there are many options available you’ll probably end up with one of the four main no-load fund providers: Vanguard, T. Rowe Price, Fidelity, and Schwab.

If you’re looking for a more comprehensive search, I’ll again have to refer you to Morningstar and their Fund Screener. Here, you can easily select to only search no-load funds and then further narrow down your search by other criteria. You’ll probably be amazed at how many no-load funds there actually are to choose from.

Expense Ratios

You’ve found a no-load fund so that means you’re all set, right? Not so fast. Loads are only one of the fees to look out for. While not all funds have loads, all funds do have expenses. These expenses are expressed in the form of an expense ratio. This makes it easy to compare apples to apples when looking at multiple funds since the fee is shown as a percentage. Looking at the example above with the Franklin Income Fund you’ll see the expense ratio is 0.62%. That means if you had $10,000 invested in this fund for a year it would essentially cost you about $62.

Unlike a front load you don’t see this expense deducted directly from your account. Instead, the expenses are built into the fund’s overall return. So if you pull up your account statement and it shows that your fund had a 4.3% return, that is your net return after expenses already. You won’t have a quarterly or annual fee deducted from your account. That’s why these expenses can be tricky because they are almost hidden and people don’t really consider the effect they have on returns.

So, make sure you’re also looking at a fund’s expense ratio before making an investment. The lower the expense the better. If you’re looking for the absolute lowest fees you should probably stick to index funds. Since these aren’t actively managed and simply track an index they can keep costs down. This means you’re looking at usually only 0.10-0.25% expense ratios on index funds. Once you get into actively managed funds it’s a different story. You might find one fund charging 0.3% and another charging 1.3%, which can make a huge difference.

Share Classes

While this won’t apply to most of you simply investing in no-load funds, it is important to be aware of the different fund classes in the event you find yourself talking to a financial advisor or otherwise who might bring them up. While not as common today as they were, there are three main types of share classes. Each share class invests in the same assets, but the difference lies in how the load is applied.

• Class A – Your standard front-end load funds as discussed above.
• Class B – Deferred sales load. No up-front load, but if you sell prior a predetermined holding period you’re charged a back-end load.
• Class C – A fixed load applied every year.

Thankfully, class B and C shares are heading the way of the dinosaurs, but that doesn’t mean they aren’t still used by some financial salesmen. They are often used to encourage an investment where they can still earn a commission by putting you into something that doesn’t appear to have a big front load like A shares. While none of these loaded share classes are good, you most certainly want to stay away from B and C.

In addition to these primary share classes you may also stumble across other odd share classes in your research. You might see something like R shares or Z shares. These are typically special share classes offered by a fund company to be used in employer-sponsored retirement plans, sold by advisors, or to institutions. You may not be eligible to invest in these classes, so make sure you check the details and investment requirements.

Recap

As you can see, understanding the fees associated with your funds isn’t all that difficult, but you can probably also see how it’s easy to underestimate the impact the fees can actually have on your returns. An expense ratio of 0.6% might not sound like much, but when you’re talking about tens or hundreds of thousands of dollars over 30+ years that can significantly eat away at your return. And with the different share classes, loads, and no-load funds available you can see how some people, namely commission brokers, will steer you into a fund that could end up costing you.

Hopefully now that you’re armed with the basics you can make sure you’re getting the most out of your funds, both with new purchases and existing holdings. Now would be a good time to dig into the details of your current investments and see how much they are costing you. If it seems high, you can always use something like Morningstar to explore your other options. And if you’re currently invested in expensive funds it might be time to look for alternatives. You can always open a free account at a low-cost broker such as TradeKing and start investing in low-cost index funds.

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Mutual or index funds are a collection of bonds, stocks or money market securities. These funds are popular choices for safer investments because they offer diversification. If one bond or stock performs poorly, another security’s stellar performance may balance the losses. Investing in a collection of securities creates a safety net for investors. In fact, a well-diversified portfolio can help you make money even while stocks are losing value.

Historically, investors can expect a typical total return of 8 percent to 9 percent over a year as a long-term average. Stocks, on the other hand, can yield 10% to 11%. Mutual and index funds are typically long term investments. Six of the best types of funds will be reviewed to help safeguard your finances.

Safest Investments

Federal Government Bond Funds

The most risk-averse investments are probably the federal government bond funds. U.S. Treasury bonds are considered safe because it is based on the government’s ability to print money and collect taxes. This eliminates most risk on behalf of a company and provides optimal protection. Even with the recent debt downgrade on the U.S. countries flooded into the Treasury market buying these securities for their safety.

Ginnie Mae mortgage-backed securities (MBS) are also considered safe investments because the securities are guaranteed by the Federal Housing Administration (FHA). Since they are securitized by the Government National Mortgage Association, they are considered safer than most investments. Including some mortgage-backed securities or federal government bonds in your mutual fund will provide more security.

Municipal Bond Funds

Municipal bond funds have a slightly higher risk than Federal Government Bond Funds. These bonds are listed by state and local governments and provide a high degree of safety to investors, because they are backed by the revenue-generating power of the issuing government. Include some municipal bonds in your mutual funds to increase your return, but maintain safety as well.

Taxable Corporate Bond Funds

If you are seeking a higher yield than federal government bonds, but less risk than stocks, taxable bond funds may be a good alternative. They do carry higher risk. However, with higher risk comes with higher yields. Investors should ask their financial advisors to recommend some high quality bonds to lower the risk associated with this type of investment. Corporate bondholders are ahead of stockholders when it comes to getting repaid due to bankruptcy.

Money Market Mutual Funds

Money market mutual funds are recommended for short term investments and provide a significant amount of security for investors. Money market mutual funds are recommended for investors that are not experienced and need a significant safety net to minimize losses. Consider money market mutual funds for diversification of your investment portfolio. But consider these basically a cash equivalent, because yields are very low, but the trade-off is the money is liquid.

Higher Risk Investments

These final securities are higher risk investments, but still considered generally considered safer than investing in just a few single stocks. Consider these investments for more aggressive returns with the benefit of diversification.

Dividends Funds and Large Cap Funds

Dividend funds are a safer way to make money while investing in the stock market. Investors experience less volatility while they focus on a steady growth by providing regular income in the form of dividends on top of capital appreciation. Consider dividends funds for a safer, but somewhat aggressive investment. Focusing on blue chip stocks is also safer than investing in smaller companies that may be slightly more volatile. Large cap stocks are typically less vulnerable to disastrous effects of an economic downturn. This will help to protect your portfolio in more difficult times in the stock market.

Hedge Funds

While not for everyone, hedge funds are designed to for people who want to make money no matter what the market is doing. Wealthy investors are often advised to invest a portion of their portfolio in hedge funds. These funds try to protect investors regardless of the market conditions. Consider hedge funds to diversify your portfolio, but only if you are very comfortable with the added risk and alternative investment types.

Where to go now?

Investing during a recession is akin to building your portfolio at a discount. When the market rebounds, your investments will increase, and the foundation of your portfolio will be built on sound investments. Recession is not the only time that people consider more conservative investments. They are also considered when a person is nearing retirement. Diversification often provides the safe haven that retirees need. With a safe haven, they can enjoy their retirement.

Invest Like a Pro

For even more information, be sure to check out Jeremy’s free Invest Like a Pro eBook. It has a ton of great information to help you research investments, track your portfolio, and invest like a pro.

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