What’s the Difference Between a 401k and a Mutual Fund?
Clarify the roles of a 401k and a mutual fund in your savings. Learn how one is a type of account and the other is an investment you can hold within it.
Many people saving for retirement question the distinction between a 401k and a mutual fund, sometimes using the terms interchangeably. The confusion is understandable because the two are closely related, but they play different roles in an investment strategy. A 401k is a type of account, while a mutual fund is a type of investment you can hold within that account.
The Role of a 401k Plan
A 401k is an employer-sponsored retirement savings account, not an investment itself. Its name comes from the section of the Internal Revenue Code that governs its tax treatment. The primary feature of a 401k plan is its tax-advantaged status, designed to encourage long-term saving. It holds the contributions you make directly from your paycheck.
With a traditional 401k, contributions are made on a pre-tax basis, which lowers your current taxable income for the year. The money within the account grows tax-deferred, so you do not pay taxes on investment gains each year. Taxes are only paid upon withdrawal in retirement, when your income and tax bracket may be lower.
Some employers offer a Roth 401k, where contributions are made with after-tax dollars for tax-free qualified withdrawals in retirement. The Internal Revenue Service (IRS) sets annual contribution limits. For 2025, this limit is $23,500. Individuals aged 50 and over can make an additional “catch-up” contribution of $7,500.
A new provision may also allow those aged 60 to 63 to contribute an even higher amount if the plan permits. Regardless of the contribution type, the growth of money inside the account depends entirely on the performance of the investments you choose to hold within it.
Understanding Mutual Funds
A mutual fund is an investment that pools money from many people to purchase a broad, diversified portfolio of securities like stocks and bonds. When you buy a share of a mutual fund, you are purchasing a small piece of the entire collection of investments held by that fund. This structure offers immediate diversification by spreading investments across various assets.
Instead of purchasing individual shares of many companies, a single mutual fund provides that variety instantly. A professional fund manager or management team makes the day-to-day buying and selling decisions in line with the fund’s stated investment objective.
Mutual funds are regulated by the U.S. Securities and Exchange Commission (SEC), which requires them to disclose information about their policies and fees in a document called a prospectus. The price of a mutual fund share, its Net Asset Value (NAV), is calculated once per day after the market closes.
Fund managers charge an annual fee, expressed as an expense ratio, to cover management and operational costs. These fees can range from less than 0.1% for passively managed funds to over 1% for actively managed funds.
Connecting 401ks and Mutual Funds
The relationship between a 401k and a mutual fund is that of a container and its contents. The 401k plan is the container, a tax-advantaged account designed for retirement savings. Mutual funds are a common type of investment, or content, that you can hold inside that container. You invest through a 401k into other products.
When you enroll in a 401k, your employer provides a limited menu of investment options. The plan sponsor selects these options to provide a range of choices suitable for different risk tolerances and retirement timelines.
This list of options consists mainly of mutual funds, ranging from aggressive stock funds to conservative bond funds. Their prevalence is due to administrative simplicity and the built-in diversification they provide. This helps employers fulfill their duty to offer prudent investment choices, which is why you use your 401k to purchase mutual fund shares.
Other Common 401k Investment Options
While mutual funds are common, 401k plans offer other investments for more tailored strategies. These options are often variations of the mutual fund structure but serve distinct purposes within a retirement portfolio.
Target-Date Funds
Target-date funds are a popular “set-it-and-forget-it” option. These are mutual funds holding a mix of other funds (a “fund of funds”), with an automated asset allocation strategy. You select a fund with a target year close to your expected retirement, like a “Target-Date 2050 Fund.” The fund follows a “glide path,” starting with a higher allocation to stocks for growth and automatically shifting to more conservative bonds as the target date nears to preserve capital.
Index Funds
Index funds are a type of mutual fund that is passively managed. Instead of a manager trying to beat the market, an index fund aims to replicate the performance of a benchmark, such as the S&P 500. Because there is no active management, these funds have lower expense ratios, meaning more of the returns stay in your account.
Company Stock
Some 401k plans allow employees to invest in their company’s stock. While this gives employees a direct stake in the business, it introduces concentration risk. Holding too much of your retirement savings in a single stock ties your financial security to the performance of one company. To maintain diversification, a common guideline is to limit company stock to no more than 10% of your portfolio.