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Mutual Funds vs. Other Investments

By David Luhman on Mon, 05/11/2009 - 23:23

Mutual Funds vs. Other Investments

Mutual funds involve risk

Money market mutual funds

Annuities offered by insurance companies

Mutual funds involve risk

Largest risk involving mutual funds is the risk that the share price will drop

Little risk that a fund will go bankrupt, but shares may lose value or the fund may be closed at a loss

By law mutual funds must invest in liquid securities

Securities held by funds are marked to market value on a daily basis - unlike bank assets

Securities are held by a third-party custodian to minimize risk of embezzlement

Money market mutual funds

Money market mutual funds are an alternative to bank accounts

Money market mutual funds offer higher interest with check writing features

Unlike banks, however, money market mutual funds are not guaranteed by the FDIC or any other organization

Still, money market mutual funds are very safe

They invest in highly liquid, high quality short-term debt

Banks, on the other hand, typically deal in illiquid assets and banks normally have only 20 cents of cash on hand for every dollar in loans

Money market mutual funds that invest in short-term US government debt can be said to be safer than bank accounts

No money market mutual fund geared towards individuals has resulted in a loss of principal, while hundreds of banks have gone bankrupt over the past 10 years

See "Bond and Fixed Income Investing for Everyone" for more information

Annuities offered by insurance companies

Annuities are a strange hybrid that combine aspects of insurance, bonds, mutual funds, and retirement accounts

Because of their high expenses, surrender fees, lack of immediate tax savings and inflexibility, annuities are not the most attractive investments available

Retirement accounts like a 401(k) or an IRA offer greater tax savings

Tax reform in the 1980s reduced the attractiveness of annuities

Annuities are possibly attractive if

You have a very high income and have already fully funded your retirement accounts

You don't have earned income but still want to shelter future earnings

you want to let your earnings grow tax-deferred after age 70.5

Still, even in these cases, annuities are not the greatest because you may do better by investing in capital assets

  • Deferred gain recognition
  • Step-up in basis for estate planning purposes

See "Bond and Fixed Income Investing for Everyone" for information on fixed annuities

See "Stock Investing for Everyone" for information on variable annuities

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