18 key financial terms

Understanding retirement terms

Retirement plan Participants preparing for their Future-Funded Ministry often feel that one of the greatest challenges is understanding the seemingly confusing “language” of investing. Knowing the following terms will get you off to a great start.

Mutual Fund

A mutual fund is a pool of money from many investors that a professional money manager uses to buy the stocks and bonds of many different companies. The purpose behind a mutual fund is to help control risk. A mutual fund may hold stocks and/or bonds of hundreds of companies across many different industries or even countries. Within a fund with multiple and diverse holdings, a single company facing struggles would probably not impact the fund since it would be buoyed by the other holdings. Mutual funds can vary from very conservative to very aggressive.

Stock

Stock represents ownership in a company. When you buy a share of stock, in exchange for the money paid for that stock, the company makes you a part owner of that company. For example: If a company sold, or “floated,” only 10 shares of stock, and you bought one share, you would literally own 10% of that company. As a shareholder, or stockholder, you do not get to make decisions about how the company is run, but you get to elect the Board of Directors, who make those decisions for you. In order to keep the shareholders happy (and to keep the Board from firing them), the management of the company must make money, and give a little back. That return to you is called a “dividend.” Mutual funds own multiple stocks.

Bond

A bond is a loan to a company. In much the same way that consumers might go to a bank to borrow money for the purchase of a home, a company might fund an enormous project by selling bonds. These bonds represent debt of the company. The company has now taken on debt, which they must repay to the bondholder, with interest, before profits can be declared. Mutual funds own multiple bonds.

Portfolio

A collection or group of investments all owned by the same individual or organization. All of the financial “stuff” you own.

Volatility

The up and down gyrations of prices of stocks, bonds and mutual funds is referred to as volatility. Typically, stock funds involve more risk than bonds, because they are not secured by the company’s assets or income, as bonds are. However, bond funds usually do not have the rate of return that stock funds do. Because of this, on any given day of the week, a stock fund usually has higher highs and lower lows than bonds funds.

Risk

The chance of loss. Investors can be categorized as conservative, moderate, or aggressive in the amount of market unpredictability they are willing to tolerate.

Diversification

The process of spreading your money among different investments. A strategy to reduce risk.

Asset Allocation

The Nobel Prize-winning economics study, the Brinson study, analyzed every transaction in the market, back to (and including) the Crash of 1929. The question it answered was this: What makes a successful portfolio? The answer may surprise you.

The single most important element of a successful portfolio is asset class. That is why diversification of a portfolio is so important.

Asset allocation simply means deciding how much money to place in different asset classes, or types of investments, at any given time.

An appropriate asset allocation helps reduce your portfolio’s exposure to volatility when the financial markets are delivering unsteady returns. This can give you peace of mind knowing your portfolio will be positioned to help meet your financial goals. Whether you are investing small amounts on a monthly basis or a large sum at one time, selecting the right mix of investments can help you achieve your financial goals.

The following chart highlights some of the best performing asset classes for the past 30+ years. The best performing asset class changes from year to year, in an almost unpredictable fashion. The difference between the best and the worst performing asset class, in any given year, can be quite substantial.

Asset Allocation Strategy Alternatives

Asset allocation is a strategy used by investors to balance their desire for growth against the risk of loss within their investment portfolio. With the abundance of investment options available, choosing investments can be complicated and confusing. Today, there are additional tools investors can use to manage their investment accounts and the ways that their investments are allocated across different investment profiles, from aggressive to conservative, and from passive to active. These investment options can also be helpful tools for investors who desire different levels of involvement in managing their investments. Depending on which options are available in your ministry’s plan, Envoy Financial can help you determine which asset allocation strategy is most appropriate to your goals, risk tolerance, and your availability to manage your investments. These strategies include the following:

Target Maturity Funds

These mutual funds are passively managed funds that become progressively more conservative as they approach the target maturity date that corresponds to an investor’s anticipated retirement year. For example, a 2040 target maturity mutual fund may include moderate or aggressive funds today, but will progressively adjust the investment mix to become a conservative fund by 2040 as a strategy to protect the core value of the investments as the investor approaches retirement age. Target maturity funds are not actively managed on a daily or weekly basis. The funds are usually evaluated on a quarterly or annual basis.

Risk-Based Funds

These funds allocate assets based on an investor’s particular risk tolerance, whether that is aggressive, moderate or conservative. The allocation in a given fund does not automatically change over time to become more conservative; rather, the investment manager of a fund invests the fund’s assets according to a targeted level of risk, such as “conservative” or “moderate.” The manager seeks to maintain the risk level of the fund over time. Investors will need to adjust their fund selections over time to help ensure that their funds actually match their life stage and the appropriate risk level.

Professionally Managed Accounts

Actively managing the investments in your retirement account can be a time-consuming and often confusing proposition. The investment landscape has grown more complicated in recent years and investment data reveals that only 7% of people ever change their investments after making their initial investment selection. Hoping your investment selections perform without ever checking the funds is not a wise strategy. Regardless of why people do not regularly evaluate the performance of their funds – education, interest, and/or time availability – a Professionally Managed Account program can help. With Professionally Managed Accounts, your retirement savings account is actively managed by professional money managers based on your goals and risk tolerance level. A Professionally Managed Account program is a fee-based service.

Dollar Cost Averaging

Investing the same dollar amount every month, regardless of market conditions and fluctuating prices, is known as Dollar Cost Averaging. Although the market fluctuates, you can use this strategy to reduce your risk of loss over time because you are investing regular amounts as opposed to a lump sum, thus lowering your average cost per share.

The following Dollar Cost Averaging chart shows that, depending upon your situation, you may be much better off embracing volatility over time, rather than shunning it and investing lump sums. Dollar Cost Averaging is a strategy to reduce risk.

Faith-Based Funds

Faith-based funds screen their investments to prevent funds from being invested in companies that earn revenue from activities that are often objectionable to a Christian lifestyle. Common screening filters prevent investment in companies that earn revenue from the following activities: abortion, pornography, gambling, and the manufacture of tobacco or alcoholic products. Envoy Financial is pleased to offer faith-based funds as an investment option for the ministries we serve. Your ministry’s retirement plan may or may not include faith-based funds.

Roth

One of the most exciting developments in retirement plans was the addition of the Roth provision for 403(b) and 401(k) plans in 2006. With Roth, investors have a choice regarding how their contributions are taxed today and how their withdrawals are taxed at retirement.

With traditional retirement plans, contributions are made before-tax, reducing taxable income. Funds contributed before-tax grow in the retirement account tax-deferred, which means that tax will be paid at a later date. When the funds are withdrawn at retirement, those funds are taxable so taxes are paid at that time.

Under Roth, contributions are made after-tax so there are no tax savings when the contribution is made. Funds grow in the retirement account tax-free and are withdrawn tax-free at retirement. No taxes are paid at retirement because taxes were paid when the contributions were made. Roth contributions are most advantageous for people who do not need the tax break today as they are in a low tax bracket and for missionaries who can take advantage of the Foreign Earned Income Exclusion.

Tax-deferred and Tax-free

Tax-deferred

Funds inside the following plans grow Tax-deferred:

  • 403(b)
  • 401(k)
  • Traditional IRA
  • Simple IRA
  • 457 Plan

Contributions to Tax-deferred plans reduce taxable income.

Distributions from Tax-deferred plans are taxed. (Licensed or ordained ministers may be partially exempt.) (For an explanation of Roth & Traditional contributions for 403(b) & 401(k) plans, click here.)

Tax-free

Funds inside the following plans grow Tax-free:

  • Roth 403(b)
  • Roth 401(k)
  • Roth IRA
  • Section 529 College Savings Plan
  • Coverdell Education Savings Account (formerly called Education IRA)

Contributions to Tax-free plans do not reduce taxable income.

Distributions from Tax-free plans are distributed tax-free when used for plan intended purposes and following IRS regulations. (For an explanation of Roth & Traditional contributions for 403(b) & 401(k) plans, click here.)

Employer Contributions: Basic and Matching

When an employer contributes into the retirement plan on behalf of an employee, those contributions are made in one of two ways:

Basic Employer Contribution

This is a contribution that an employer makes into an employee’s account regardless of the employee’s participation in the plan. It is usually a percentage of the employee’s salary and often increases each year the employee remains with the organization. Your ministry’s retirement plan may or may not include a Basic Employer Contribution.

Matching Employer Contribution

This contribution only occurs when the employee contributes into the retirement plan. When the employee contributes, the employer also contributes a certain amount, “matching” some percentage of the employee’s contribution, usually up to a specified maximum percentage of the employee’s salary. A matching contribution is often described in this manner: A dollar-for-dollar match, up to 6%. This means that the employer would contribute $1 for each dollar the employee contributes, up to 6% of the employee’s salary.

A Matching Employer Contribution is generally regarded as “free money” and employees should take advantage of these funds as a tool to build their “Future-Funded Ministry” plan. Your ministry’s retirement plan may or may not include a Matching Employer Contribution.