Personal finance author Gail MarksJarvis says investing isn't complicated -- if you understand some important definitions and basic principles. The key to investing is to diversify among funds that invest in different types of stocks and bonds, she says, and not to pick several funds that invest in similar stocks, for example. To learn how to diversify properly, you first have to understand how different mutual funds work.
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MarksJarvis offers a simple guide to making sense of mutual funds by explaining how to evaluate their performance and the true cost of a fund as it compares to others. No math skills necessary.
What kind of fund do you have?
 What are some of the vocabulary terms that people need to know?
 I've been writing about this for about 10 years and people have no idea what the words mean or what the importance of the words are. So they'll typically call me and say, "I have a mutual fund and it's losing money" or "I have a mutual fund and my friends are doing much better. Should I sell my fund?" Well, the fact that it's losing money is absolutely irrelevant if it's a certain type of fund in a certain type of stock market.
For example, in the year 2000, almost every mutual fund that invested in stocks was losing money. The fact that your mutual fund was losing money didn't mean anything because if you were invested in the stock market, you were going to be losing money. What would've been important is if you were losing more money than other funds like yours.
If you're investing in large stocks, you would compare your fund to the index that includes large stocks, and that's the Standard & Poor's 500 index. When Wall Street refers to the stock market, they are referring to that index. It's a rough measure of the stock market, even though it only includes 500 large stocks. But if you have a fund and you are paying a fund manager to select stocks for you and your fund manager is choosing only large stocks and the stock market has been climbing about 8 percent a year and your fund is climbing about 5 percent a year, then you might have a problem if that continues for two or three years.
The funds in a 401(k), or anywhere actually, are divided into three different categories.
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Three basic asset classes: |
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Stocks. There are stock funds, and sometimes you will see the word "equity" on those. Rather than worrying about the word "equity" when you see it, just think stocks. |
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Bonds.
Then there are bond funds, but sometimes
those are called fixed income because bonds
are supposed to guarantee you a certain
interest payment regularly and that means
fixed income. So, they'll call it fixed
income, but when you see the words, just
think bonds. |
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Cash.
When experts talk about cash, it could mean
money in a savings account or money market
fund -- money that is going to be very,
very safe and is not going to grow much
at all. People think they want that because
it's safe -- they can't lose money in it
-- but if they're saving for many, many
years, that's actually dangerous, because
the money grows at such a small pace. People
might think that's safe -- and it is; you're
not going to lose any money -- but you're
not going to make enough money. |
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So those are the three categories that you need to know.
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