It's Costly to Not Know the Basics of Investing

The average American knows very little about investing and sees it as a daunting task. The minefield of investment terms like, 401a, 403-b, 457, 529, and 12b-1 sound more like a quarterback calling an audible. As a result, most people rely on their company's 401k plan, or have no investments at all. Will your future be costly because you're uninformed about investing and are afraid of taking charge?

In a passive sense, employer 401k's are better than not planning for retirement at all; and many employers deposit additional dollars to the employee so you would have to be crazy not to take the money.

Basically, 401k plans place your money into a mutual fund or funds. When you invest in a mutual fund, you are buying "shares" (ownership) in a company whose business is to take the "mutual" pool of money and invest it in a specified and "diversified" (spread out to lower risk) area of the market buying "stocks" (ownership) and/or "bonds" (loans) in companies.

In short, you own shares in the mutual fund company and if the fund invests well, then your investment in the company grows. In this way, you can have a diversified "portfolio" (total of investments) without having to have the tens of thousands of dollars needed to buy stocks/bonds in a multitude of companies to spread out risk.

But here is the fly in the ointment; the plans are chosen by the company and managed by yet another company; and employees are given a narrow selection of mutual funds in which to have their money deposited. The problem is that far too many of the fund "choices" are, for lack of a better word, garbage. The result, mediocre returns. In addition, many of these employer provided instruments have high fees that needlessly eat away at your hard earned dollars. They may make it easy for you to invest, but that ease comes at a cost you need not pay.

If you have a 401K with employer contributions, you need to know the best fund choices for your money. Otherwise, everyone should actively research and open an investment account in at least one solid performing mutual fund on your own. You do not need a "stock broker" or "financial planner" to invest. You can work directly with a mutual fund company. They will send you a monthly statement so you can keep track of your account with no worries.

Some simple advice and guidance will give you the confidence to take action and move you to becoming a self-directing investor with returns that will make you proud.

With thousands of mutual fund choices, what fund should you invest in? If you have a computer and know some basics, the choice is at your fingertips. There are many mutual fund screeners and comparison websites to guide you through the process. Favorites include: Yahoo finance, Morningstar, Kiplinger, Lipper, and Max Funds to name a few.

Here is what to look for in finding that great long term above average performing fund. If you stick to these parameters, you can feel confident in downloading the application form, sending a check, and opening an account for the long term. The result, your future will begin to look brighter, and with it you will gain peace of mind.

• Pick the "category" (type and style of fund) in a "no load" (no up-front cost) US stock fund. Look for a large growth, value, or blend fund (basically the biggest and best US companies known as "blue chips." A "multi-cap" (different size companies) fund might also be a good choice. If you want bonds to further diversify, look for a "balanced" (stock and bond) fund.

• The minimum initial investment amount must be affordable for you? Many accounts can be opened up with as little as $200-$500 dollars.

• The expense ratio should be under 1%, and there should be no 12b-1 fees.

• 10 year performance of 9% is a benchmark to shoot for.

• A manager's tenure in running the fund should be over 10 years.

• The fund turnover of holdings should be low, look for less than 20%.

• For yield/dividend percent, obviously the higher the better.

• Look at long term ratings from Morningstar, Lipper, Forbes, etc. Don't even look at return numbers less than 5 years.

• The "net assets" (how many dollars the fund has invested) is telling. Remember, bigger is not always better. A rule of thumb: 500 million to 1 billion in assets.

• If the "subsequent" (minimum) investment amount is affordable, set up your investment with an "AIP" (automatic investment plan) so dollars are deducted from your bank account monthly to purchase more shares of your fund. It's as easy as setting up an automatic pay plan like you have probably done with, for example, your car payment.

• When filling out the application don't forget to check the boxes to reinvest "dividends" (profits) and "capital gains" (profits when the fund sells shares it owns); that way the fund will take your earnings and purchase you more shares growing your account balance even faster.

• If you plan on investing less than $5500 a year into the account, you should designate the account as a "ROTH IRA" (special tax category) so that at age 59½ withdraws are tax free.

• Don't be afraid to call the fund company and ask questions. You will be surprised at how helpful customer service will treat you. After all, they want your business, and they are not the cable company.

• The "prospectus" (everything you need to know about a fund) can be found on-line, as well as forms to download and every imaginable slice of data you would ever need.

If you want to take your search to the next level, you can check out these "performance metrics" (statistics) to compare your choices. Here is an easy to understand guide.

• Standard deviation: shows volatility. The lower the number, the better.

• Mean annualized arithmetic performance average. The higher, the better.

• Sharpe ratio: shows risk adjusted performance. The higher the better.

• Alpha: shows performance verses what Beta predicts. A positive Alpha is good.

• Beta: the greater, (than the benchmark of 100) the better.

• Treynor ratio: shows performance. The higher the number, the better.

• R-squared: shows how much movement in fund is explained by factors inside the fund, i.e. management. In a well performing fund, the lower the number below 100, the better.

As you can see, even the novice investor can feel confident in what they are researching and make informed purchasing decisions that take the worry about pulling the trigger on taking charge of their investments. The price of fear and being uninformed has a cost. Take charge now, call that audible, your future will thank you.