How Mutual Funds Can Be Used for Retirement

A senior couple reviewing their mutual fund retirement investments.

Mutual funds are commonly used for retirement planning because they offer diversification, professional management and reduced risk when compared with other investments. These investment vehicles pool money from multiple investors to buy a diversified portfolio of stocks, bonds, or other securities, with each investor owning shares proportional to their investment. A financial advisor can help you determine how mutual funds could fit into your retirement plan.

What Are Mutual Funds?

The Massachusetts Investors Trust is credited with the establishment of the first open-end mutual fund in 1924. This offered individual investors the opportunity to pool their money and invest in a diversified portfolio of securities. Mutual funds later surged in popularity because they could offer professional asset management and diversification to everyday investors.

Mutual funds are managed by professional fund managers, who are tasked with the buying and selling of securities within the fund’s portfolio. When you buy shares in a mutual fund, you are acquiring a portion of the fund’s collective assets. The value of these shares is captured in the net asset value (NAV), which is the total value of the securities owned by the fund, divided by the number of shares outstanding.

How Mutual Funds Are Beneficial for Retirement Planning

Mutual funds are often chosen as part of a larger retirement plan. Here are five common reasons:

Diversification: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. This diversification helps spread risk across various assets, which can be crucial for long-term retirement planning. With a single mutual fund investment, an individual can gain exposure to a wide range of securities, reducing the risk associated with investing in individual stocks or bonds.
Professional management: Mutual funds are managed by professional fund managers who make investment decisions on behalf of the fund’s investors. These managers conduct research, analyze market trends and actively manage the fund’s portfolio to achieve its investment objectives. For retirement planning, having access to professional management can be advantageous, as it relieves individual investors of the responsibility of actively managing their investments.
Accessibility: Mutual funds are accessible to individual investors through various channels such as brokerage accounts, employer-sponsored retirement plans (e.g., 401(k) plans), and individual retirement accounts (IRAs). This accessibility makes it convenient for individuals to invest in mutual funds as part of their retirement savings strategy. Additionally, many mutual funds offer automatic investment plans, allowing investors to contribute regularly, which can help in building a disciplined approach to retirement savings.
Range of options: Mutual funds come in a variety of types, including equity funds, bond funds, balanced funds, target-date funds and index funds, among others. This range of options allows investors to choose funds that align with their risk tolerance, investment goals and time horizon for retirement. For example, younger investors with a longer time horizon may opt for equity funds that offer higher growth potential but also carry more risk, while those nearing retirement may prefer more conservative options such as bond funds or target-date funds that automatically adjust the asset allocation based on the investor’s retirement timeline.
Reinvestment of dividends and capital gains: Many mutual funds offer the option to reinvest dividends and capital gains distributions, allowing investors to compound their returns over time. Reinvesting these earnings can significantly enhance the growth of retirement savings, especially when compounded over several decades.

Potential Risks of Relying Only on Mutual Funds for Retirement

A man researching how he could invest in mutual funds for retirement.

While mutual funds can be an integral part of a retirement savings strategy, relying solely on them for retirement planning may present several risks and limitations:

Market volatility: Mutual funds are subject to market fluctuations, which can impact the value of investments. Depending solely on mutual funds for retirement could expose investors to market volatility, especially if their investments are concentrated in a particular sector or asset class. Market downturns close to retirement could significantly affect the value of the portfolio, potentially delaying retirement or necessitating a change in lifestyle during retirement.

Fees and expenses: Mutual funds typically charge management fees and other administrative costs, which can eat into investment returns over time. While these fees are often reasonable, they can reduce overall returns, especially if an investor holds multiple funds with high expense ratios. Over the long term, excessive fees can significantly erode retirement savings.

Lack of control: When investing in mutual funds, investors delegate decision-making authority to fund managers. While this can be beneficial for those who prefer a hands-off approach to investing, it also means relinquishing control over individual investment decisions. Fund managers may make decisions that don’t align with an investor’s goals or risk tolerance, potentially leading to suboptimal outcomes.

Underperformance: Not all mutual funds outperform their benchmarks or deliver consistent returns over time. Relying solely on mutual funds for retirement may expose investors to the risk of selecting underperforming funds. Poor fund performance could lead to lower-than-expected returns, jeopardizing retirement goals and financial security.

Lack of customization: Mutual funds offer pre-packaged investment portfolios that may not be tailored to an individual’s specific financial situation, goals or risk tolerance. Depending solely on mutual funds for retirement may result in a lack of customization, potentially leading to an inappropriate asset allocation or investment strategy.

Inflation risk: Over the long term, inflation can erode the purchasing power of retirement savings. While mutual funds offer the potential for capital appreciation, failing to account for inflation risk could result in a diminished standard of living during retirement.

To mitigate these risks, individuals should consider diversifying their retirement portfolio beyond single mutual funds. This may include incorporating other investment vehicles such as individual stocks, bonds, exchange-traded funds (ETFs), real estate and alternative investments.

Bottom Line

A senior couple discussing mutual fund investments with a financial advisor.

Mutual funds can be of interest to investors seeking diversification, professional management and accessibility to various asset classes, yet they should not be the sole vehicle for retirement planning. While they simplify the investment process and offer a level of risk mitigation, it’s critical to balance their benefits with their inherent costs, tax considerations and potential market risks. A strategic approach to retirement planning involves integrating mutual funds with other investment types and regularly rebalancing the portfolio to align with one’s evolving financial goals and risk tolerance.

Tips for Retirement Planning

A financial advisor can help you create a financial plan for your retirement needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You can also estimate how much you might need in retirement by utilizing a retirement calculator.