Investing 101: Buy your first stock or fund

Those loads eat into your investment gains, so there is no reason to buy a load fund unless you are relying on a financial advisor or broker to help you pick funds. In theory, it's that advice you're paying for.

Managed funds vs. index funds

Managed funds employ a fund manager, who picks the stocks he or she thinks have the best chance to rise in price.

By contrast, index funds attempt to match the composite investment gains of all stocks making up a particular category, such as large companies, small companies or technology companies. Or, in some cases, to match the investment gains of the entire stock market.

Since, in theory, fund managers wouldn't choose obvious losers, you'd think that most managed funds would readily outperform index funds. But that's not necessarily the case. Sometimes they do and sometimes they don't. The relative performance of managed funds vs. index funds depends on the particular index and time period that you analyze.

Here are two no-load managed funds that have consistently outperformed the overall market over the past five years:

• Fairholme (FAIRX, news, msgs): a blend of small-, mid- and large-cap stocks in both the value- and growth-priced categories.

• Kinetics Paradigm (WWNPX, news, msgs): mostly mid- and large-cap stocks in both the value- and growth-priced categories.

• Fidelity Select Medical Equip/Systems (FSMEX, news, msgs): a blend of mid- and large-cap growth-priced stocks in the health-care industry.

Here are two no-load index funds:

• Wilshire 5000 Index Portfolio (WFIVX, news, msgs): It emulates the Wilshire 5000 Index ($TMW.X, news, msgs), which essentially tracks the entire U.S. stock market.

• Vanguard Small-Cap Index (NAESX, news, msgs): It emulates the Russell 2000 Index ($RUT.X, news, msgs), which tracks small-cap stocks.

Index funds vs. exchange-traded funds

Within the index fund category, you have another choice: traditional index funds vs. the new kid on the block -- exchange-traded funds (ETFs).

The primary difference between exchange-traded funds and conventional funds is that ETFs trade just like stocks. You pay the same commissions you would for buying or selling stocks, and there is no limitation on trading activity.

For that reason, active traders prefer ETFs. However, because you pay a commission every time you buy, ETFs are not suitable for investors who want to invest on a regular basis -- say, monthly (a smart strategy known as dollar-cost averaging.)

Here are two index funds available as ETFs:

• Diamonds Trust (DIA, news, msgs): It tracks the Dow Jones Industrial Average, a group of large, established companies chosen by the editors of The Wall Street Journal.

• NASDAQ 100 Trust (QQQQ, news, msgs): It tracks the Nasdaq 100 Index, which in turn tracks the 100 largest nonfinancial stocks listed on the Nasdaq stock exchange.

Buying and selling mutual funds

Many mutual funds have similar names, so it's best to use ticker symbols when you research and trade mutual funds.

Unlike stocks, where you specify the number of shares you want to buy or sell, for mutual funds, you usually enter the dollar value that you want to trade. If you're using a discount broker, most give you -- on their Web sites -- a way of seeing the minimum purchase requirements and applicable transaction fees when you enter a fund's ticker symbol. (Our Easy Fund Screener has similar information.) When you buy, you must specify whether you want dividends and capital-gain distributions from the fund credited to your account in cash or reinvested in fund shares. Dividends are profits paid by companies to their shareholders, in this case, the fund. A fund realizes capital gains when it sells shares of a stock whose price has gone up. Most investors choose to reinvest the distributions.

Conventional mutual funds (not ETFs) trade only once daily, after the market closes. If you miss the deadline for the day you enter the trade, your transaction will be processed after the market closes on the following day.

When you sell fund shares in a regular brokerage account, your broker will tell you whether you've realized a gain or a loss on the sale. You will have to pay taxes on any gains (unless the shares are held in a tax-deferred account like a 401(k)). Your year-end brokerage statement should show your total gains or losses for the year and how to report them on your tax return. Click here for more information on how to minimize the tax bill on your investments.

Mutual funds are a good way for beginning investors to get into the market. After you've got your feet wet, you may want to move on to individual stocks.

At the time of publication, Harry Domash did not own or control any of the securities mentioned in this article.

< previous |  1 | 2 |