By Steve Hauser
In the January issue, we used index funds to build a portfolio but never really defined what that means. Let’s do that now.
A common question from the beginning of time has been “How’d the market do today?” Originally, the answer was “How the hell would I know?” Then someone came up with the idea of an index. Basically, an index is a number of stocks that when grouped together might represent the market. Some early examples are the Dow Jones Industrials or the Dow Jones Transports, etc. Standard and Poor’s got into the mix with the S&P 500 index. It covered most of the market by using the 500 largest companies in America. Today there are hundreds of indexes covering everything.
Before, during or after this time, another bright idea was to group different stocks together to create an easier way to invest and mutual funds were born. A mutual fund can consist of stocks, bonds, options or just about anything.
It was only a matter of time before someone stuck their chocolate into someone else’s peanut butter and voila! Index Mutual Funds.
Exchange Traded Funds (ETFs) soon followed offering an alternative to Mutual Funds. They trade more like a stock instead of once a day. Either one will work when building a portfolio.
The bottom line is watch out for expenses. If your mutual fund is a “loaded fund”, that’s a fee paid to your advisor and can be as high as 5% or more. Some are paid when you buy, some when you sell and some bleed you out for the duration that you hold it. “No Load” mutual funds are what to ask for and demand from your broker. They’re very common. Both mutual funds and ETFs will have annual fees called an Annual Expense Ratio. The smaller the better.
While the indexes carry on indefinitely, the stocks within them can come and go. The thirty stocks in the Dow Jones Industrial Index are not the same ones that were there at the start. When one gets dropped, another is picked up to replace it.
The web site listed below will provide more detail if you’re not sure which one is best for you. If you don’t care either way and want the short answer, go with ETFs.
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