When you first start an account you likely won't have very much money in it. If you leave it as cash or even in a money market it will just sit there, no matter what the stock market does. You could buy a stock in that account but then 100% of your investment is dependent on what that one company does. What if you accidentally choose an Enron or a Lehman brothers and it goes bankrupt?
One way to avoid that risk is buy LOTS of companies- the odds of more than one or two going bankrupt are pretty small. You can't realistically do that with your $2000 though- each time you buy stock you get charged a fee! So instead you buy a mutual fund.
A mutual fund is a portfolio of stocks that a manager likes. Usually they're separated out by type. For instance, you might have a mutual fund that only invests in European companies, or only in companies that are tracked by the S&P 500 index, or only in companies that are worth more than $10 billion (i.e., "large cap"). The manager of the mutual fund buys and sells stocks in the portfolio as he or she sees fit.
In exchange for managing this portfolio, a fee is built into your performance returns. This fee is called the "expense ratio." The higher the expense ratio, the better the manager has to do to make up for it.
Want to look under the hood of your mutual fund? Check out morningstar.com and type in its name. Even better, see if you can find out it's "ticker" symbol, which is a mutual fund's unique 5 character code that ends in X. That's the best way to do it because there are a lot of funds that look almost identical- I mean, check this out!
That one's particularly crazy, but you see the problem!
OK, I'm going to go into some Morningstar detail because 1) I LOVE IT & 2) I'm loitering around Steve's Auto Repair waiting for my car to be finished with it's summer servicing.
1) for simplicity's sake, I'm picking a mutual fund whose ticker I already know. I'm choosing Parnassus Fund. It's an old, local, socially responsible investing fund that tends to take its investors on a bit of a roller coaster ride. It's ticker is PARNX.
1) Type it in the field that says "Quote" in greyed out text up top of the page.
- Check out its rating. 5 stars is best (though studies have shown that a portfolio consisting of 100% 5-star funds doesn't do as well as one made up of a mix of 3s, 4s, and 5s. That's because all ratings on based on their old performance. Some are probably on their way up and some on their way down.)
- Check out what kind of fund it is: This one primary invests in Large companies (worth $10 billion or more.)
- Check out how much it takes out in fees.
- Check out how it's done compared to the rest of the large cap funds.
3) This is the "under the hood" part. What's IN this mutual fund? See the "Portfolio" tab just over the "Expenses" arrow? Click on that. First you can see the overview of what TYPES of stocks that manager chooses. You can see that although it's listed as "Large Cap" he actually invests in all sorts of companies. It's just MOSTLY large cap.
3a) Under the hood, continued. See the tiny "Holdings" up at the top of this? Click on that to see what stocks he actually buys.
Ta da! It only tells you the top 25 stocks but that's most of the portfolio. Also, tomorrow they may be different but it's unusual for portfolios to change that much.
So if you're curious to know what's in that mutual fund (maybe you have them in your work retirement accounts?) this is a good, free way to do it.