Difference Between a Mutual Fund & a 401k

Understanding your investment options is an important step in developing a successful financial plan.

Understanding your investment options is an important step in developing a successful financial plan.

Understanding financial investment options can be tricky. Many types of financial accounts and even more kinds of investment products have emerged over the years. Some investment options offer tax advantages, but these advantages come at the expense of additional regulations. With some background knowledge, you'll find that understanding the basic workings of 401k accounts and mutual funds is relatively easy.

401k Basics

A 401k plan is a type of retirement savings plan offered by businesses for their employees. As an employee, you can contribute to a 401k by deferring part of your salary into the 401k. These contributions are made with pre-tax dollars, which both reduces your income taxes and lowers your gross income for the purposes of calculating eligibility for other tax deductions and credits. Money inside a 401k grows tax-deferred, which means you don't have to pay taxes each year on interest earned or on any investment gains.

Mutual Fund Basics

A mutual fund is a type of investment product. The investors in a mutual fund pool their money. These funds are then used to invest in individual securities such as stocks and bonds. An actively managed mutual fund invests as directed by a professional money manager. A passively managed mutual fund invests in a way that attempts to replicate the performance of an index or other benchmark. The mutual fund's profits and losses are passed on to individual investors in the fund.

401k Investment Options

Many types of investments are allowed inside a 401k plan. Self-directed 401k plans allow you to choose your own investments. Traditional 401k plans offer a menu of investment options selected by the company as it administers the plan. Most 401k plans offer a selection of mutual fund investments. As an employee, you can choose how your contributions are allocated among the various mutual funds that are offered.

Mutual Funds Inside 401k Plans

Most mutual funds offer different versions. These different versions are known as share classes and are often represented by a letter. For example, a mutual fund may be offered as A shares, B shares and C shares. In addition, many mutual funds have special share classes for use within 401k plans. These share classes may have higher or lower overall expenses than the more common retail share classes. As a result, the performance of a mutual fund inside a 401k plan may not match the performance of the same mutual fund's non-401k shares.


About the Author

Brian Nelson is a professional freelance writer and owner of ArcticLlama Freelance Writing. Brian is a former certified financial planner, has experience in computers and technology, and is a MCSE. He has a degree in biochemistry from the University of Colorado. Nelson has written for numerous publications and websites, including eHow, Corporate Eye, Finance Gourmet, and Train Signal Training.

Photo Credits

  • Jupiterimages/BananaStock/Getty Images