After years of limping along at historically-low levels, interest rates on savings accounts, government bonds and certificates of deposit show few signs of rising. While this is great news for first-time home buyers looking for deals on 30-year mortgages, it's not ideal for older folks looking to goose their retirement savings accounts. After factoring in the effects of inflation, most savings accounts and short-term certificates of deposit actually offer negative real returns.
In this low-interest environment, safe financial products that promise annual returns greater than 3 or 4 percent are hard to come by. While the stock market has recently produced excellent returns for active investors who maintain highly diversified portfolios, it's also highly volatile and subject to punishing corrections and crashes. It may not be ideal for "conservative" investors who wish to grow their funds at reasonable but not eye-popping rates.
Many financial experts argue that mutual funds offer an advantageous compromise between the safe, low-interest savings vehicles offered by traditional banks and the high-risk, high-reward equities that populate the stock market. These diversified baskets of equities are selected and managed by qualified teams of financial professionals rather than computer programs or armchair investors. They're regularly adjusted to reflect the changing realities of the global economy. Such active money management isn't free: Mutual funds typically retain between 1 and 2 percent of their total earnings to cover labor and overhead costs. This fee is known as the "expense ratio."
Over the long term, the rates of return on most mutual funds handily outpace the benchmark rate of inflation. However, a given mutual fund's rate of return may vary wildly from year to year. If the stock market as a whole gains 30 percent during a given year, most mutual funds will follow suit. Better-managed funds may increase in value by more than 30 percent while weaker funds may increase by less than 30 percent. On the other hand, a sharp fall in the broader market is likely to be reflected in falling mutual fund values.
Some financial gurus claim to know of mutual funds that produce 12 percent annual returns on a long-term basis. This is misleading: While some older funds have technically produced 12 percent annual returns over the course of many decades, their rates of return have been dropping for years. These days, a given mutual fund is unlikely to produce growth in excess of than 6 percent.