Expert: Gina Boykin - 8/27/2007

Question
I am 20 years old male who currently working to collect money to enrol university.I understand only investment can mutiple my money effectively.However,I know a little or almost nothing about investment.I invest just to grow money for my future life.I prefer steady and safe investment.What type of investment suits me?Mutual fund or bond or??Hope you can guide me.Thanks.

Answer
If you are trying to raise money for school, and will be going in less than 5 years, you may want to consider a plain old savings account or certificate of deposit, which are around 5% if you select a good online bank (see www.bankrate.com to compare rates).

If you want to invest for a longer time-frame (preferably 10+ years) you can start by looking at an index fund or a money-market funds, which are types of mutual funds.

First let me explain what a mutual fund is.  Think of it like this.  You have a big jar that you put $1,000 in.  Nineteen of your friends also put in $1,000 so you have a total of $20,000.  You have all "mutually funded" the jar.  This jar is given to a broker, who invests the amount in 20 different stocks.  You now each have a little bit of the 20 companies.  If you had invested $1,000 on your own, it would be very hard to own stock in 20 different companies.  This broker's job is to make sure the fund makes money.  All day he researches companies, trends, the economy, and the industry.  That's his job.  He gets paid from the fund's earnings as "management expenses".  Management expenses usually run 1%-3% of the fund's balance, and reduce your actual gain.

Now to index funds.  If you've ever watched CNBC, they talk about the DOW and the S&P 500, and sometimes the Russell 2000.  These are all indexes.  They represent a large number of stocks.  For example, the S&P500 represents the largest 500 companies and the Russell 2000 represents the 2000 smallest (A.K.A. "small cap stocks").  If you purchase an index fund, you own all of the stocks that are in the index.  You can buy stock index funds and bond index funds.

Index funds have these advantages:

#1- Best for beginners. You don't have to do much comparison and research when it comes to an index fund.

#2- Less fees. The fund manager of an index fund doesn't do much research, because he has to buy the same stocks that are in the index.  Because he spends less time working on these funds, his salary doesn't get charged much to the fund either.  The management expenses are much lower for index funds (0.1%-0.5%).

Here's why that is important.  If you invest $1,000 in an index fund, and $1,000 in a mutual fund, the mutual fund will have to provide a better return just to cover the management expenses.  Let's say the index fund has 0.25% of expenses and the mutual fund has 2.25% of expenses.  If the index fund returns 11% per year, the mutual fund needs to be at at least 13%.

This does not mean that investing in a mutual fund is bad.  Just check the expenses.  There are many that have low management fees.  I'd stay away from any over 2%.

#3 - Lower capital gains.  There's not much buying and selling going on in an index fund.  For other mutual funds, they may keep some stocks less than a year, which means there are capital gains taxes on the sale of these stocks.  More fees means less profit to you.  How can you tell?  You can look at the "Turnover Ratio".  This tells you how often the stocks are traded - or turned over.  A higher % means more trades and higher capital gains.

#4 - You'll always meet the market's return.
Fund managers work very hard to try to get a better return than the index (they try to beat the S&P, for example).  Some do, and some do not.

If you do decide to look at mutual funds, here are some things to consider:

1.  Fees.  Get a no-load fund (load means fees are paid when you buy or when you sell).  Compare the management expense %. Avoid 12-b1 fees.  If you pull up a mutual fund, go to the Summary of Expenses section and you will see all of the fees.

2. History of returns.  Look at the 10-yr and/or 15-yr average returns.  Anything less than 10 year may not give you the true picture. (remember, this means you plan to leave the money in for 10 years...)

3.  Your risk tolerance.  You mentioned that you want something steady and safe.  You have the option of a bond index fund, stock index fund, money-market mutual fund, balanced fund, growth & income fund, growth fund, aggressive growth fund, and international fund.

The absolute lowest risk mutual fund is a money-market mutual fund.  This is different from a money-market account (which is a checking acct that pays interest).  A money-market mutual fund invests in government securities and CDs and are considered very safe.  The returns are much lower, of course.

You may want to look at a "Balanced Fund" or a "Growth & Income Fund".  These have both stocks and bonds, so they don't move up and down as much as a Growth, Aggressive Growth, or International Fund would.  

Remember, no investment is completely without risk.  However, also remember that inflation eats away 3-4% of your money each year.  If you don't put your money in something that makes more than that, you are LOSING money each year.  And that is not safe!

Here are a couple of websites that are great for beginners.

www.investopedia.com
www.fool.com
www.indexfunds.com
www.thestreet.com