your 401(k) #12: Int'l & Dividend Funds
pLUS COMPANY STOCK!
So far, we've covered a decent chunk of the equity mutual fund universe, focusing specifically on domestic, or US-based, funds. You may also be able to invest in certain international funds, dividend or income funds, and company stock.
International stock funds invest in - yep! - international stocks, or companies based outside of the US. Some may invest specifically in what are called emerging markets. These are developing countries like Brazil, Russia, India, and China that are trying to grow, open their economies to the world, and emerge, or step out, onto the global stage. Investing in these transitional countries can offer high growth potential but can also be risky since they're vulnerable to economic and political unrest.
Other types of international funds include:
- Global funds
- Invest primarily in international companies, but also some US stocks.
- Worldwide funds
- Invest in an unspecified mix of companies around the world.
- Regional funds
- Invest in companies from certain regions of the world, such as Latin America, Europe, Asia, etc.
(Not too difficult, right?)
Then there are specialty funds, like sector funds and thematic funds.
- Sector funds
- Invest in companies from specific sectors, or business lines. (For a refresher on sectors, check out THE BASICS #9: Sectors, Industries, & Indices). Examples include funds that only invest in technology, healthcare, energy, and financials.
- Thematic funds
- Invest in companies across sectors that stand to benefit from a specific theme or trend in the economy.
- For example, let’s say the government is set to pass a bill to increase infrastructure spending. An infrastructure fund may invest in certain construction, transportation, energy, and utility companies that could win new contracts created by the increased infrastructure budget.
Since specialty funds are more focused, investing in them can allow you to capitalize on certain trends. However, because they’re more concentrated, they’re also higher risk. Whereas most mutual funds spread your money and risk across many different baskets, specialty funds place all of your eggs into only a few baskets. And if those baskets drop? Well, there go your eggs!
Dividend funds, also called income funds, take a slightly different approach to buying stocks than most mutual funds. Instead of relying solely on price appreciation (stock prices going up) to make money for their investors, dividend funds earn additional income by investing in stocks that pay dividends.
What are dividends? Remember, when you own stock in a company, that entitles you to a (tiny) percentage of the company’s future profits. Some companies actually pay out a percentage of those profits to shareholders. This payment is called a dividend, and it’s yours to keep no matter what happens to the company’s stock price in the future.
Some dividends are paid out at the end of the year, and how much you get per share depends on the company’s profits. Others are paid out quarterly, or every three months.
- For example, I own a stock that pays a $1.25 per share every quarter, or a total of $5.00 per share per year.
- Five bucks might not sound like a lot, but if you own enough shares, that dividend income can really add up!
That’s exactly a dividend fund’s MO: own millions of shares of various dividend paying stocks to generate current income for its investors. Typically you’ll have to decide how you want to receive your dividend income. Some funds distribute the cash directly to your account, while others will automatically reinvest that money in new shares of the mutual fund. That's called a Dividend Re -Investment Program, or DRIP for short.
The last bit of the equity world that I want to talk about is company stock. If you work for a company like AT&T or Apple (just examples), some of your compensation may be paid out in shares of the company.
Companies do this for a couple of reasons:
- Issuing stock is often cheaper than paying cash bonuses
- Company stock is used to align employee and company interests (ie you work hard because you want the company to grow and its stock price increase).
There are typically stipulations to these shares. You can’t sell them for cash right away, have to hold onto them for X# of years, can only sell them if the stock reaches a certain price in the future, etc.
In some instances, company stock can be extremely valuable. Just look at the early employees of companies like Facebook and Apple; they’re sitting pretty today! But you should beware of owning too much company stock. You already rely on your company for income to pay your bills and feed your family. Do you really want to rely solely on them for your retirement too? Remember, don’t put too many of your eggs in one basket. Ask employees of Enron how that turned out for them in 2002...
Two points to ponder about company stock:
- If you’re going to own shares in your company, make sure to consult research or a third party opinion about it. What’s the company’s outlook? Are share prices expected to go up or down in the future?
- Experts suggest limiting your company stock exposure to 5-10% of your investments.