Financial Literacy - Financial tuneup
Gail MarksJarvis
investing
Simple guide to mutual funds

I hear this a lot from people in their 20s. They turn on their TV and they hear Jim Cramer on "Mad Money" on CNBC saying, "This is a great stock. Buy it." And they think because he said so, they should. But their chance of winning, even though Jim Cramer may be very right about what that stock looks like today, their chance of winning down the line may be very different.

Things happen with stocks that people can't predict. For example, people look at Kmart, and years ago, people would have said, "Those Kmart stores are everywhere. You can't lose on Kmart stock." But Kmart ended up having trouble after a certain period of time and the company went bankrupt.

When a company goes bankrupt, as a stockholder, you usually lose all the value of your stock. Mutual funds usually have about a hundred or more stocks in them. If one stock goes bankrupt, there are many other winners in the fund that will help you get through that.

Compare your fund's performance

q_v2.gifSo, if you compare your fund to the correct index and you see yours is doing worse, does that mean you have a bad fund and that you should sell it?

a_v2.gifSay you just notice the problem in your 401(k) at the end of this quarter. Then you say, "Oh, I wonder if this fund has always been a laggard" or if it's been better in the past. Then, you look up the fund on Morningstar.com, you type in the symbol -- five letters that identify the fund -- and you will see by clicking on "performance" how your fund compares to other funds like it. And if, for the last five years, your fund has been a laggard -- even for two years, but especially for five years -- you have to ask yourself, am I in the best fund?

“Things happen with stocks that people can't predict.”

Usually, if your fund is trailing it's because of two things: First of all it's very difficult to pick stocks, it's very difficult to be a winner, and most mutual funds do not win compared to the simple stock market. If you could just throw your money in a stock index fund, you would beat about 70 percent of all the brilliant mutual funds out there.

This is pretty simple stuff. There are all these people with MBAs (Master of Business Administration) who are trying to outsmart the stock market and they're not able to do it and you have a very simple vehicle in front of you, which would be a simple stock market index fund, and you could probably do it with that. Not every year, not every quarter, but over the many years of saving for retirement. One year, one quarter, probably means very little.

Look at expense ratios and loads

But if it's two years and especially if it's five years, at that point I would probably look at one number called the expense ratio. That sounds like a math number, which makes people nervous because it has the word "ratio" in it. But you don't have to do any math. You can just look at the number. The expense ratio is a number you can find in three ways: You can look it up in the materials that you received with your mutual fund, under fees and expenses. Or you can just ask your mutual fund company, "What is the expense ratio for my fund?" Or you can ask your financial adviser, if you have one. The average for a mutual fund would be about 1.4 percent. But even better, the average for larger mutual funds would be a little less than 1 percent.

Even better would be if you got one of these simple index funds that I'm talking about and paid less than a quarter of 1 percent, which of course, would look like 0.25 percent. Find one even lower than that, if possible.

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The reason you would do that is, it's very, very difficult for a stock picker to outsmart the stock market and to pick all the right funds. I've had fund managers tell me that they're usually disappointed with about 40 percent of the stocks they've picked. And they know what they're doing. So it's hard to beat the stock market.

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