The best long-term vehicle available to us are mutual funds. What are they?

History
"Stock" or "equities" as the TV Money Nerds like to call them is a piece of ownership in a company. The company sells itself to the public through the process of the Initial Public Offering - the public's first chance to become part owner in a newer company. The company issues some number of shares, and each share is priced based on the value of the company. After that, these shares are bought and sold back and forth on an "exchange" like the New York Stock Exchange or the NASDAQ and the price is variable. As the company grows and makes more money, each share becomes more valuable. Some companies share their profits with the shareholder owners in the form of "dividends" that are paid out according to how many shares one owns. The research and specialized knowledge of an industry that is required in order to make educated choices about which companies are going to be competitive going forward and which are out of ideas are daunting to say the least. So....

Way back in the 1920s, the only people who owned stock were rich people, because they had a monopoly on the knowledge and access required to trade stocks. So some clever individuals figured out that they could gather money together from several or many different investors, and put it all in a big pot. Then they could, using their research and specialized industry knowledge, take that money and buy a basket of different stocks. This basket of stocks obviously has a value consisting of the varying values of the stocks they bought. Now we have some number of investors, each of which has contributed some amount of money, and that money has been traded in for a bunch of different stocks. Each person's "share" of the pot buys shares of this new entity we have (get ready this is profound) mutually funded. Ta daah, a mutual fund is born. The calculated value of each share is referred to as the Net Asset Value, or NAV. That's the price you see listed for any share of any mutual fund on the Money section in the USAToday.

So a mutual fund is nothing but us putting money into a pot in order to gain access to the specialized knowledge possessed by an investment company. These companies employ small armies of research specialists to investigate every intricacy of the industries they are interested in. They normally end up with stock in between 90 and 200 different companies.

If the managers of the mutual fund use the money to buy companies whose earnings are expected to grow going forward, it is known as a Growth Stock Mutual Fund. If they are buying companies based in other countries it's an International or World Stock Mutual Fund. If they buy some companies that are expected to grow earnings as well as some that are more stable and tend to pay substantial regular dividends it is known as a Growth and Income Mutual Fund. A Small Cap (capitalization) Mutual Fund buys smaller startup companies that have big up sides and big downsides as well.

Spreading a substantial nestegg across several of these different types of mutual funds tends to decrease risk. For example Large Cap Growth companies tend to move somewhat out of cycle with Small Caps. This out of cycle movement tends to dampen the volatility enabling you to sleep just fine. This spreading around of money is called "diversification" by financial planners and other Money Nerds.

With all that as background let's dive into the account names. Bear in mind that the name "IRA" or "401k" is NOT AN INVESTMENT TYPE. It's simply the tax treatment that is applied to whatever the underlying investment happens to be. So you can have an IRA with the money invested in bank CDs or you can have an IRA with the money invested in mutual funds.

IRA - Individual Retirement Arrangement. There are 3 types I'll list from best to worst:

ROTH IRA - named for Delaware Senator William Roth, bless his soul. The Roth is funded with after tax (take home) income. It then gets invested over the course of your working lifetime and (get ready) IS NEVER TAXED AGAIN!! All the growth, the compounding, the contributions, - all TAX FREE!!

TRADITIONAL IRA - the one your parents have. Money is contributed before taxes, then grows tax deferred until you take it out after age 55. Then it's taxed at regular income tax rates.

NON-DEDUCTIBLE IRA - funded with after tax money, it grows tax deferred until retirement, then it's taxed at regular income tax rates. Not a great deal, but it's all you've got if your income gets too high and pisses off Democrats.

401k - named for Section 401, Subsection k of the tax code. It is currently the most prevalent employer-based retirement plan. Money is contributed pre-tax and may be matched by employer contributions to one degree or another. Grows tax deferred until retirement, then taxed at normal income tax rates.

403b - also named for the relevant sections of the tax code, this is most prevalent among teachers, nurses, and non-profit organizations. Pretty much the same as a 401k with the excellent exception that the employee is allowed to roll his accumulated contributions out of the plan and into his own IRA once per year, which is good because most teacher's 403b investment options absolutely stink.

Your employee benefits or benevolent HR dweebs will be able to explain the investment options that are available through any company-sponsored 401k or 403b plans so you can GET YOUR MONEY OUT OF THE MONEY MARKET OPTION AND INTO THE MUTUAL FUND OPTIONS SO YOU WILL RETIRE WITH SOME MONEY.

OK...ummm mind if I ask what prompted you to post this here?

it's pretty random LOL

Random informative posts about money are why we love Dorkfish.

There's another thread going that sorta begged for a broader explanation of this stuff so I unburdened myself. And no, I don't mind that you asked. It is a bit, umm... unprompted.

OK just curious. This thread caught my eye cause I'm a CFP

You should include some information about dollar cost averaging... (if your not already typing it out)

FYI in my opinion NOW is the perfect time to DCA into the market if you can afford it. I think we've hit the bottom and feel that the DJIA will be over 15000 before the end of the year...

great post mr. dorkfish.

j

You should include some information about dollar cost averaging... (if your not already typing it out)

Ask an ye shall receive:

http://www.gixxer.com/forums/showthread.php?t=169832

This poor-titled thread explains dollar-cost-averaging. Additionally, I offer this link to the dollar-cost-averaging calculator on the American Century Investments website:

http://fc.standardandpoors.com/htdocs/calculators/adol/calculator.jsp?toolid=000587

right now i have a non employer funded 401k.....should I stop paying into that, and put it in a ROTH? it seems like a better deal for me in the long run.

And if so, I take the money out, will I be taxed for taking it out and re-investing in something else?

right now i have a non employer funded 401k.....should I stop paying into that, and put it in a ROTH? it seems like a better deal for me in the long run.

And if so, I take the money out, will I be taxed for taking it out and re-investing in something else?

If you take the money out of your 401K you'll be taxed on it as ordinary income PLUS a 10-15% penalty from the IRS for withdrawing it before your 59 1/2. There are a few exceptions where you can withdrawal early such as the purchase of a first home or to help pay for health care expenses if something tragic happens.

As far as your work goes...they don't offer any kind of match? Most employers will match 50% on the dollar up to like 6%...

What Are Mutual Funds

It's a group of individuals investing together to form a fund (The fund consists of a # of stocks with various holding percentages)
If a fund has 90% Apple stocks & 10% in others, than you just invested in Apple.

Look into the individual companies that the fund is invested in, every single one & the %'s they're invested in. Then decide if the fund makes sense to you.

They are managed by someone you've never heard of, and that as far as you know are relatively intelligent.
It's less volatile than stocks per say but it's still very volatile.

You can't just set it & forget it, check that bitch every day or week, don't panic.
Dump it if you lose more than %10.
Don't care what the fuck it is, you drop it.

Have fun, beware of high Mgmt Exp. Ratio (MER) and Management Fees, look into it, research the fund, who runs it, they're track record, etc, etc

Find a BANK that will let you buy & sell as much as you want without fees.

There's also minimums to certain funds, some are $50,000, some are $100.

There's also early sell fees (around 90 days) they nick you with a percentage of the total if you sell within 90 days after purchase, but sometimes it's cheaper than holding on.

Don't do it half assed, it's you're hard earned money.
The more you make, the more you make.
You want you're money to be making money.

Click on this link and surf around, look at the history charts, company profile etc, etc. Give you a good idea as to what I'm talking about.

Somewhere in there are the fund fees, look at those closely, a 5% fee on a 4% fund equals a loss.

Good luck.
http://www.globefund.com/servlet/Page/document/v5/data/fund?style=na_eq&id=18210&gf_uid=globeandmail.gf.02719569454

check out First Eagle Global

www.firsteaglefunds.com

Loco's point about selling a fund if it loses more than 10% is not quite right. You can look at the dollar-cost-averaging thread I posted to figure out for yourself why you don't want to be jumping into and out of the market at large. Other research data demonstrates that jumping in and out of one particular mutual fund is counter-productive. In a nutshell, there is a substantial difference over time between what is known as "fund return" and what is called "investor return". This research indicates that the average return realized by individual investors in a particular mutual fund (investor return) tends to be a good bit below the actual fund return. Why? Because they jump in and out. Jumping out after losses and back in after recoveries is what is called "buy high, sell low" and is pretty much the exact opposite of what you want to be doing. It costs you a couple of percentage points of return that the fund earned and you didn't. That is not to say you should stick with a crappy pick forever. Look at a fund's performance relative to it's peer group. If it's an emerging markets fund, I guarantee you are going to have swings bigger than +/-10%. That's how emerging markets funds behave - huge swings that you have to ride out. The relevant point of comparison is whether your emerging markets fund is underperforming the average of all the other emerging markets funds, and the index that tracks the performance of emerging markets in general. If your fund loses 12% in the first quarter of '08, but the average emerging mkt fund lost 15%, you're doing fine. Conversely, you may be impressed when your fund returns an average of 15% per year for 4 years running - until you compare it to other e.m. funds and they're averaging 18%.

Is that clear, or did I make mud-pies with that explanation?

The other point about looking at the individual stocks inside a mutual fund is fine, but not necessary. First of all, the whole point of a mutual fund is to buy the stock-picking expertise of professional fund managers. If your assumption is that you have to agree with their picks, you're saying you could do just fine without them, which is almost never true. Secondly, they are not required to publish up-to-date information on their holdings unless that holding represents more than 5% of a particular company, so you don't actually know day by day what the fund is invested in anyway.

Wealth-building is a slow, steady, long-term process. Dollar-cost-averaging into an array of good mutual funds that cover several areas of the economy, setting up an automatic plan that happens every period no matter what, paying attention but not obsessing.... These are the elements of a successful financial plan.