Problems With a Retirement Mutual Fund TVM
Original post by Eric Feigenbaum of Demand Media
Investors and savers alike have to consider the effects of the time value of money (TVM) before making financial decisions. Traditionally, mutual funds have been a way that many planning for retirement turn TVM to their advantage, ensuring the yield of their investments is worth more than their money in hand today. However, under certain market conditions and circumstances, a dollar in the hand today may remain worth more than the yield of a mutual fund -- thereby making mutual funds a less useful vehicle for retirement investing.
Time Value of Money
Economists use the term "time value of money" to describe the idea that a dollar today is worth more than a dollar at any point in the future. Because of inflation and continual economic changes, currency becomes weaker over time. Therefore, money hidden under a mattress may be safe, but it loses value by the day. However, by lending or investing money, a person can sustain or even increase the value of her money.
Interest and Yields
Banks and other financial institutions pay a premium for the use of account holders' money. This is known as interest. Depositors give banks use of their money not only for safekeeping, but to ensure they get enough return to prevent their savings from losing value due to TVM. However, interest has a limited and fixed return. Those who want their money to become worth considerably more in the future than in the present -- or essentially to turn TVM around to their advantage -- invest their money in businesses. Some elect to create their own businesses, while others use financial securities such as stock and mutual funds to buy ownership in publicly traded companies. Ideally, the yield of these investments will produce greater sums down the line -- which has made them a popular means to plan for retirement.
Dips and Losses
Mutual funds that fail to perform -- or worse, lose value -- can actually increase the TVM problem. They make it so that an investor's dollar was worth more before investing than it was afterward. Of course, this is the opposite of what an investor and intended retiree wants. However, a mutual fund currently selling for less than an investor's purchase price isn't a loss. Loss only occurs when an investor sells for less than she bought. That means holding on to a mutual fund may correct the problem as prices and dividends rise. In the long run, if the selling price eventually reaches more than the purchase price, an investor can still turn a profit and succeed in her retirement goals.
Some mutual funds pay dividends -- profits shared with shareholders. Dividends are important when examining an investment and its relation to TVM. Even if a mutual fund's share price drops, the fund can continue to be worth more than TVM so long as its dividend yield remains above the rate of inflation. Accordingly, a mutual fund giving an average quarterly divided on 7 percent may still yield a shareholder more than cash or a bank deposit, even if share price has dropped -- particularly if a retiree plans to live off the dividends of her investments, rather than dive into the principal.
- IRS.gov: Topic 404 - Dividends
- StudyFinance.com: Time Value of Money
- Council for Economic Education: Time Value of Money
- Investing-In-Mutual-Funds.com: The Time Value of Money
- MSN; 1-Fund Retirement - Buy and Forget; Liz Pulliam Weston
About the Author
Eric Feigenbaum started his career in print journalism, becoming editor-in-chief of "The Daily" of the University of Washington during college and afterward working at two major newspapers. He later did many print and Web projects including re-brandings for major companies and catalog production.