A Beginner's Guide To Mutual Fund Investing With Fidelity 401(K)

Investing in mutual funds through a 401(k) is a great way to build a diversified portfolio of stocks, bonds, or short-term investments. Fidelity, a world leader in mutual funds, offers a wide range of investment options, including domestic equity funds, international equity funds, and sector funds. With over 70 years of experience in the industry, Fidelity has the tools and expertise to help investors build an investment strategy that aligns with their goals and risk tolerance.

When investing in mutual funds through a 401(k), it is important to consider the different types of accounts available, such as brokerage accounts, 401(k)s, and Individual Retirement Accounts (IRAs). Each account type has its own set of pros and cons, and choosing the right one depends on factors such as tax implications, contribution limits, and investment flexibility.

Additionally, investors should be mindful of the various types of mutual funds offered by Fidelity, including target date funds, asset allocation funds, and sector funds. By carefully considering their investment objectives, risk tolerance, and time horizon, individuals can make informed decisions about which mutual funds to include in their 401(k) portfolio.

Understand the benefits of investing in mutual funds

Mutual funds are a practical and cost-efficient way to build a diversified portfolio of stocks, bonds, or short-term investments. They are a type of financial instrument that pools money from many investors and invests in securities like company shares, bonds, stocks, debts, and other assets. Here are some of the benefits of investing in mutual funds:

• Risk diversification: Mutual funds help investors diversify unsystematic risks by investing in a diversified portfolio of stocks across different sectors. While individual stocks have both unsystematic and systematic risks, mutual funds are only subject to systematic or market risk.
• Smaller capital outlay: Mutual funds allow investors to start investing with relatively small amounts. Since mutual funds are based on the pooling of money, investors can own a diversified portfolio of stocks with a much smaller capital outlay.
• Investment expertise: Investing in stocks and bonds requires considerable expertise and experience. Mutual funds are managed by professional fund managers who have the necessary qualifications, expertise, and experience to pick the right stocks or other instruments to maximize returns while minimizing risks.
• Economies of scale in transaction costs: Mutual funds buy and sell securities in large volumes, so transaction costs per unit are much lower than what individual investors may incur if they buy or sell shares through stockbrokers.
• Variety of products and investment modes: Mutual funds offer investors a wide range of products, such as equity funds, hybrid funds, debt funds, liquid funds, and tax-saving schemes, to suit different investment requirements and risk profiles. Investors can also choose from various investment modes, such as lump sum, systematic investment plans (SIP), systematic transfer plans (STP), and systematic withdrawal plans (SWP).
• Disciplined investing: Mutual funds encourage investors to invest over the long term, which is essential for wealth creation. Systematic investment plans (SIPs) help investors maintain a disciplined approach to investing, taking emotions out of the investment process.
• Liquidity: Open-ended mutual funds are highly liquid investments, allowing investors to redeem their units usually on a T+3 (transaction + 3 days) basis.
• Transparency: Mutual funds disclose their Net Asset Values (NAVs) at the end of each business day, providing investors with daily updates on the market value of their units. Monthly Fund Factsheets are also published, disclosing portfolio holdings and other relevant information.
• Tax advantages: Mutual funds offer tax benefits that may be more favourable than those of traditional fixed-income investments. For example, in equity funds, short-term capital gains are taxed at a lower rate, and long-term capital gains are tax-exempt up to a certain limit.

Overall, mutual funds provide a flexible, accessible, and well-regulated investment option for individuals looking to grow their wealth over the long term.

Learn how to open a 401(k) account

If you're self-employed, you can open a 401(k) plan for yourself as a solo participant. In this case, you can contribute as both the employee and the employer. For example, as an employee, you can contribute up to a maximum of $22,500 per year ($30,000 if you're 50 or older) in 2023. On top of that, you can contribute up to 25% of compensation as a business owner.

If you're not self-employed, your employer may automatically sign you up for a 401(k) plan when you start a new job. Some employers may sign you up with a relatively low contribution rate. If your employer offers matching contributions, be sure to contribute enough to get the full benefit. In general, saving at least 15% of your pre-tax income for retirement is recommended, including any matching contributions from your employer.

If your employer doesn't offer a 401(k) plan, there are other options for retirement planning, such as opening a traditional investment retirement account (IRA), investing in mutual funds and annuities, or creating your own pension with a Simplified Employee Pension (SEP) plan.

• Decide how much to contribute: Aim to save at least 10% of your gross wages, starting with your first paycheck. If you can't afford 10% right away, start smaller and increase your contributions whenever you get a raise.
• Get a 401(k) match: Take advantage of any employer match offered, as this can boost your retirement savings significantly.
• Consider a Roth 401(k): A Roth 401(k) may be a good option if you're currently in a low tax bracket, as contributions are made with after-tax dollars, and withdrawals in retirement are tax-free.
• Scrutinize autopilot settings: Pay attention to the default investment strategy and make sure it aligns with your financial goals.
• Pick diversified 401(k) investments: Choose a mix of stock funds, bonds, and cash that fits your personal risk tolerance.
• Keep 401(k) costs low: Be mindful of the fees and expenses associated with the investments offered by your company, as these can reduce your returns over time.
• Balance retirement saving with other expenses: It's important to balance retirement savings with other financial goals, such as paying off high-interest debt and building an emergency fund.
• Roll over your 401(k) when you change jobs: Instead of cashing out your retirement account when you leave a job, consider rolling over your 401(k) to your new employer's plan or transferring it to an IRA to avoid penalties and continue tax-deferred growth.

Explore different types of mutual funds

There are many different types of mutual funds, each with its own investment focus and strategy. Here are some of the most common types of mutual funds:

• Stock Funds: These funds invest in corporate stocks and can be categorized by the size of the companies they invest in (small-cap, mid-cap, or large-cap) or their investment approach (aggressive growth, income-oriented, or value).
• Bond Funds: Bond funds invest in bonds and other fixed-income securities. They can be further categorized into government bond funds, corporate bond funds, and high-yield bond funds.
• Money Market Funds: These funds invest in short-term, low-risk debt instruments, such as U.S. Treasury bills and certificates of deposit (CDs). While they offer better returns than savings accounts, they are not insured by the FDIC.
• Index Funds: Index funds aim to replicate the performance of a specific market index, such as the S&P 500 or the Dow Jones Industrial Average (DJIA). They are passively managed and tend to have lower fees than actively managed funds.
• Balanced Funds: Also known as asset-allocation funds, balanced funds invest across different types of securities, such as stocks, bonds, the money market, or alternative investments. The goal of these funds is to reduce risk through diversification.
• Target-Date Funds: These funds hold a mix of stocks, bonds, and other investments, and the mix gradually shifts to become more conservative as the target date (usually retirement) approaches.
• Income Funds: Income funds focus on providing a steady stream of income by investing in government and high-quality corporate debt. They hold these bonds until maturity to provide consistent interest payments.
• International Funds: International or foreign funds invest only in assets located outside of the investor's home country.
• Regional Funds: Regional funds focus on a specific geographic region, such as a country, continent, or group of countries with similar economic characteristics. They invest in securities of companies headquartered or generating significant revenue within the targeted region.
• Sector and Theme Funds: Sector funds aim to profit from the performance of specific sectors of the economy, such as finance, technology, or healthcare. Theme funds cut across sectors, focusing on specific themes or trends, such as AI or clean energy.
• Socially Responsible Funds: These funds, also known as ethical funds, invest only in companies and sectors that meet certain criteria. For example, they may avoid investing in industries like tobacco, alcohol, or weapons. Sustainable mutual funds focus on green technologies, such as solar and wind power.

Compare mutual funds with other investment options

Mutual funds are a practical, cost-efficient way to build a diversified portfolio of stocks, bonds, or short-term investments. They are a good option for those who want to invest but don't consider themselves experts, as they are managed by a team of investment professionals.

There are a few different types of mutual funds, including equity, debt, and hybrid funds. Each of these categories has multiple sub-categories, and there are currently over 2000 mutual funds in India alone.

When comparing mutual funds, it's important to look at more than just short-term returns. Here are some other factors to consider:

• Long-term performance: While short-term performance can be volatile, mutual funds have the ability to grow your wealth in the long term.
• Consistency of returns: A fund that consistently delivers the same level of returns is a better investment than one that has a few bouts of extraordinary performance.
• Downside protection: During volatile markets, a fund that offers downside protection will minimise your investment losses.
• Performance against the right benchmark: When investing in an actively managed fund, you are looking to earn higher returns than what most funds of the same category are delivering, not just beat the index.
• Risk measures: There are several key risk measures to look at, including standard deviation, the Sharpe ratio, the Sortino ratio, alpha, and beta.
• Portfolio details: The portfolio details allow investors to see the sectors and specific stocks or bonds that the fund has invested in. This can help you understand the level of concentration risk.
• Modified duration: This tells you about the level of interest rate risk a debt fund is taking.
• Credit rating of the portfolio: A high credit quality portfolio means the fund has lent to borrowers that are financially strong, so the risk of borrowers not paying interest or the principal amount is low.

Mutual funds can be compared to other investment options, such as stocks, bonds, and short-term investments. Each option has its own risks and potential rewards, and the best option for an individual will depend on their financial goals and risk tolerance.

For example, stocks can offer higher potential returns but also come with higher risk. Bonds typically have lower returns but are considered safer than stocks. Short-term investments, such as money market funds, offer short maturities and minimal credit risk but may have lower returns.

It's important to consider all relevant factors and consult a financial professional before making any investment decisions.

Get started with investing in mutual funds

Step 1: Figure out what you're investing for

You might be itching to get started with investing in individual stocks, but it's important to first consider what you're investing for. Many people start off by investing for retirement, and this is a good place to begin.

Step 2: Choose an account type

If you're investing for retirement, you'll probably want to start with a 401(k) or an individual retirement account (IRA). A 401(k) is an employer-sponsored plan for investing for retirement, and may be the most readily available investment account you encounter. IRAs are accounts for retirement that you can open and invest in on your own.

Step 3: Open the account and put money in it

If you're opening a 401(k), you'll do this through your employer. With an IRA, you'll need to choose a financial institution to open your account with. You'll then need to decide how much money to invest. With a 401(k), you contribute through payroll deductions, meaning the money is taken out of your paycheck automatically. You decide how much of your pay to contribute. If your employer offers matching contributions, consider investing at least enough to capture the full amount of the match. For example, if your employer offers a dollar-for-dollar match up to 3%, you would contribute 3% to take full advantage.

Step 4: Pick investments

This is where mutual funds come in. Mutual funds pool together money from many investors to purchase a collection of stocks, bonds, or other securities. You can use them like building blocks, putting a few together to create a portfolio. Or, you can buy an all-in-one fund, which is an easy-to-manage diversified portfolio in a single fund. If you're investing in a 401(k) or IRA, one option to consider is a target date fund—an all-in-one professionally managed fund that's specifically designed with a target retirement date in mind.

Step 5: Buy the investments

You'll generally look up the investment's ticker symbol—a string of 1 to 5 letters that's unique to that investment—then decide on a dollar amount or number of shares to buy. In a 401(k), it's often easiest to set up your investment choices when you're setting your regular contribution amount, in which case your money will be invested in the choices you've selected automatically, corresponding with your pay cycle.

Step 6: Relax (but also keep tabs on your investments)

Now that you have a portfolio, try to remember that it's normal for investments to bounce around over the short term. Try to stay focused on the big picture, like your long-term investing goals and your total portfolio's performance. Over time, you'll want to periodically (at least annually) check in on your plan.

Frequently asked questions