Buying Mutual Funds
Suppose you’ve saved $3,500, and you’re ready to begin investing. You’re thinking about getting into a mutual fund, and you heard the guys at work talking about a cool telecommunications fund. It sounds good, and you want to know more about it. Where do you go? You have two choices:
Call a stockbroker, a professional buyer and seller of investments, and ask about the fund. Go directly to the mutual fund. Either go to the library, check out the fund online at www.morningstar.com, or find the telephone number of the fund and let your fingers do the walking.
We’ll talk about the different types of brokers a bit later in the chapter. For now, think about whether you know anything about this fund you’re thinking of jumping into. How has it performed over the last five years? Is it considered risky? Find out everything you can about the fund before you decide whether to buy it. Get a mutual fund directory and read about the fund. The report will have a toll-free number, which you can call and get information about the fund. This information usually comes in the form of a prospectus. After you have the prospectus, read it thoroughly and learn as much about the fund as you can. The prospectus is a detailed explanation on an investment. There are several mutual fund directories, such as the Morningstar report or Value Line, which track and offer information on thousands of mutual funds. They are available at your local library. They’re also available online. Find Morningstar at www.morningstar.com, and Value Line at www.valueline.com. Opening a new account with a mutual fund isn’t exactly a stroll through the park. After you contact the mutual fund or the stockbroker, you’ll receive a new account form. You’ll need to provide all kinds of information, such as where you work, the name of your bank, your first transaction, your investment knowledge, your driver’s license number and expiration date, your Social Security number, and many, many other things. If you’re fairly financially savvy and willing to do your own research and make investing decisions, then an online broker probably is fine for you, but don’t forget to do your homework before signing up with one. Also, check out the online sites listed in the following:
E*Trade at www.etrade.com TD Waterhouse at www.tdwaterhouse.com Charles Schwab & Co. at www.schwab.com Ameritrade at www.ameritrade.com
After you’ve handed over all the pertinent information and the mutual fund company has opened an account for you, all you have to do is tell them that you’d like to buy XYZ Mutual Fund. The person on the phone will tell you how much it will cost, and you state whether you want in and how much money you want to invest. After a verbal agreement is reached, you’ll get a written confirmation. Always check the confirmation as soon as it arrives to verify that the transaction is correct. If it is, immediately send a check to the mutual fund to make the deal final. After you’ve bought in to the fund, you’ll either get a monthly or quarterly statement, showing you the value of the fund. It will also include what income has been paid out in the fund, whether more shares have been purchased, the price of the fund today, the share price of the fund when you purchased it (which some fund statements provide), and the like. You also will get an annual statement at the end of the year and a 1099 form to use when you prepare your income tax return.
Understanding Index Funds
An index is an unmanaged group of securities whose overall performance is used as a standard to measure investment performance. Most people consider the Dow Jones Industrial Average (known as the Dow) as the measure of the market. This measure is an index (group) of 30 large, industrial stocks. While the Dow might be the most visible index, the S&P 500 (Standard & Poor 500) is a better measure of the market. This index is a grouping of corporations drawn from various industries by their size—the 500 largest U.S. corporations. These firms account for over 80 percent of the market capitalization (size) of all the stocks listed in the New York Stock Exchange. An Index Fund is a passively managed mutual fund that seeks to parallel the performance of a particular market index. A mutual fund company sets up a mutual fund that mirrors the index by including shares of all the firms that make up the index. An investor can purchase an index fund, which seeks to match, rather than outperform, the return and risk of the market. The advantage to indexing is that there are minimal trading costs. The grandfather of all index funds is Vanguard’s Index 500 Fund. This fund was so successful that there now are myriad index funds. There are bond index funds, domestic stock index funds, international/global index funds, and even industry-specific funds. When an investor calls a mutual fund company and instructs the firm to buy or sell fund shares, the trade is not made until the end-of-the-day pricing of the fund. On a wildly volatile day, you could call in an order at 10 a.m., only to have to sit and watch the market plummet or skyrocket all day. To get around the end-of-the-day pricing, Wall Street invented exchange-traded shares, a group of securities that represent a mutual fund, but are traded in the stock market throughout the day, at the market value at that time. This way, an investor can own an index fund, and still be in control of market timing. The downside is that there’s a brokerage fee associated with exchange-traded shares that doesn’t occur with a regularly traded index fund.
Buying Stocks or Bonds
The way you buy stocks and bonds is very similar to buying mutual funds. You work with a broker to buy or sell stock. There are a couple different varieties of brokers. You could use a full-service broker, who charges about 1 percent of the value of your investment. What are you getting for your money, you ask? Hopefully, the broker you’d be working with would have good knowledge and information concerning your particular investment, and you would benefit from his or her expertise. Discount brokers are brokers who are paid a salary by the company for which they work, rather than working on commission. This makes them very attractive to many investors who recognize the potential for a conflict of interest among brokers who work strictly for commission. Some analysts say you can save 50 percent or more by buying from the big discount brokers such as Charles Schwab or TD Waterhouse Securities, rather than from the traditional brokerage firms such as Merrill Lynch and Morgan Stanley. Full-service or discount broker? The choice is yours. If you feel you need advice and direction, look for a full-service broker. If you know what you want, or you have another type of financial advisor, a discount broker should be fine.
