IRAs Vs Mutual Funds: What's the Difference?

IRAs are great vehicles for saving for retirement. Though they are subject to income limits and yearly contribution limits, most Americans are eligible for one or both of these accounts. However, many beginner investors have no idea where to start - they are bombarded with misleading advertisements and are either bewildered by or unaware of the vast array of investment options available to them. They don't understand the basics, so they go along with whatever the IRA salesperson at their bank suggests, without knowing whether it's really the right investment for them.

Because mutual funds are a popular choice for retirement investors, many beginners confuse IRAs and mutual funds. Banks do very little to clear up this confusion, often advertising their proprietary mutual funds with an IRA account so that they are inseparable in the minds of their customers. This confusion works to the bank's advantage, but it may cause an unsuspecting investor to buy inappropriate investments for his or her IRA. Here's a breakdown of the differences.

An IRA is simply a type of account. It's nothing more than a holder for your retirement money. With the money inside your IRA, you can invest in or buy just about any type of investment you want, including stocks, bonds, mutual funds, CDs, even real estate. You can open this type of account at banks, credit unions, brokerage houses and through online brokers. Before opening an IRA, an investor should determine what types of investments he or she wants to hold inside the IRA. The type of investment will most likely determine where to open the account, because not all types of investments are available through all banks or brokerages. For more information, check the series introduction article for a link to an upcoming article titled "Where Should I Open an IRA?"

A mutual fund is a type of investment, which can be held inside of many types of accounts, including IRAs, 401Ks and brokerage accounts. Mutual funds are made up of many different stocks and/or bonds, depending on the focus of the fund. There are literally thousands of mutual funds out there to choose from, and you can hold any of them inside your IRA. For information on how to decide between the multitude of mutual funds available, check the series introduction article for two upcoming articles in this series, titled "What are Asset Classes?" and "What is an Asset Allocation?"

Other articles in this series dedicated to mutual funds ("What are Mutual Funds?") and IRAs ("What is an IRA?") may also be helpful in clarifying the differences between IRAs and mutual funds. Understanding these basics will help you gain confidence as you explore the wide world of investing in mutual funds inside your IRA.