Here's a trick even Doug Henning can't top: How can you invest in the stock market without actually buying stocks? Presto! The magic comes via mutual funds, a marvelous yet too often misunderstood way of getting started in stocks. Mutual funds are simple, so let's unlock the lexicon. "Mutual" means together, or shared. "Fund" means money. A mutual fund pools thousands of investors' money and buys a portfolio of investments designed to achieve a particular goal. There are tons of types: for one, stock mutual funds invest in stocks. Bond mutual funds invest in-you guessed it-bonds.
Why buy a stock mutual fund instead of buying individual stocks? Professional management. When you invest in mutual funds, you don't have to sit around analyzing stocks, tracking interest rates or charting commodity prices. The actual buy-and-sell decisions about what makes up the fund's portfolio are handled by the fund manager, whose entire job is to pick securities he or she believes will appreciate in value. You pick the fund, but the fund manager picks the stocks, bonds or other investments that make up the fund's portfolio.
Strapped for cash? Another big plus for investing in mutual funds is that you don't need big bucks to get started. Most will let you open an account with as little as $500, and you can add to your investment in increments as low as $50. Also, instead of shuffling piles of paperwork, you'll get seriously simplified bookkeeping. The mutual fund company will send you regular statements, plus confirmations whenever you add or withdraw money from your account.
Not every stock is a winner, so you never want to put all your investment eggs in one basket, but with only a few thousand to invest, it's almost impossible not to. But a mutual fund won't just hold one stock or bond, but dozens of them. Another major advantage: as an investor, you own a tiny piece of all those investments. You're getting big diversity without spending big bucks.
Invest in a fund, and you'll be given shares. Not shares of stock, mind you, but shares of the mutual fund. These represent your portion of the pie, or how much of the fund's overall assets are actually yours. The "shares" of a mutual fund are each given a value, which is called the net asset value (NAV). This is the fund's "price." But unlike a stock, fund companies will gladly issue you fractional shares. Most people find it easier to refer to the dollar amount they've invested in a particular fund rather then the number of shares.
For those not using full-service brokers, there are two major ways to buy mutual funds. One is to "go direct." Unlike stocks or bonds, which must be bought through a broker, mutual fund companies will allow you to open an account directly with them. Almost all have toll-free numbers you can call to ask questions and request written information. The other way to get into mutual funds is to open an account with a discount brokerage, where you'll have a variety of options. The fund will be held in your brokerage's account just like a share of stock.
Whether you're buying directly or through a discount broker, make sure you check out the prospectus-Wall Street talk for a document issued by the mutual fund that outlines the goals, strategies and risks of a particular fund. The prospectus also contains all the pertinent information regarding the fees the mutual fund will be charging. Fees? Absolutely. Funds are not free. You'll pay a small percentage of your cash, usually about 1.5 percent, to the investment company that runs the fund. Fees have a big impact on your bottom line, so concentrating on low-cost funds is a must.
If you think picking stocks is daunting, picking a good mutual fund can be downright difficult. Why? Selection, for one thing. Variety might be the spice of life, but with more than 11,000 mutual funds to choose from, even savvy stock-pickers get frustrated in "fundland." In fact, there are more mutual funds than there are companies trading every day on the New York Stock Exchange.
If you're just starting to put together a portfolio, a great place to begin is Morningstar's Web site (http://www.morningstar.com). The site offers an unbiased perspective and useful tools-most available at no charge.
No matter what type of mutual fund you choose, make sure your interest, dividends and capital gains are being reinvested into the fund as shares and not sent to you as cash. This helps instill a doctrine of discipline into your investing plan, and when it comes to reaching monetary goals, it's that long-term focus that ultimately benefits your bottom line.
Jonathan Hoenig is a radio personality, market commentator and principal at Capitalistpig Asset Management in Chicago.