Most of us, starting an investment plan, look to the stock market to build a little savings into a big nest egg.
But Wall Street can be a formidable force, evidenced by last week's 554-point bail out. And finding good stocks takes time, skill, and money. It's a practice perhaps best left to professionals.
That's why mutual funds are so attractive, says Suze Orman, a financial planner in Emeryville, Calif.
Funds can "get your feet wet" in the world of stocks and bonds, Ms. Orman says, and give you access to the brightest minds and best track records.
No matter how humble your investment kitty, you can always find a fund that provides "instant diversification" for your money (assets) and diligent management - at a modest fee.
Mutual funds have become the undisputed king of the investment hill since the early 1980s. Some 40 million American households have invested more than $3 trillion in 7,000 funds.
Mutual funds are investment companies that pool money from many investors and then buy a collection (a portfolio) of stocks and/or bonds.
The "net asset value" or NAV of each share, listed in newspaper tables, changes based on what happens daily to the value of the stocks or bonds in the fund.
The NAV is essentially the share price when you buy or sell your stake in a fund.
For example, suppose you decide to invest in the Janus Twenty fund mentioned in the chart at left. The minimum, initial investment is $2,500 ($500 to open a retirement account), or $500 plus regular, monthly investments of $100.
So let's say you take the minimum plunge for $500. Janus Twenty's NAV is about $36.59, so you now own 13.66 shares of the fund. But what you really own is a small piece of all 20 stocks in the fund: Citicorp, United Airlines, General Electric, for example, all of whose shares cost lots more than $36.
(Worth noting: Janus Twenty has been a star performer, but its star manager recently left.)
Here are some basic steps to getting your fund feet wet.
Step 1: Know thyself
Know how you work - your investment goals and strategies. Consider three fundamentals:
1. Have a goal. One rule of thumb says your retirement account should amass 15 times the annual income you hope for, if you retire at age 66 (not including Social Security or pension income). Many fund companies offer worksheets to plot your goals.
2. Determine your tolerance for risk. Stocks have sharp ups and downs, for example, but a "risk-free" cash fund (also called a money-market fund) will barely outpace inflation.
3. Know your investment time frame. It varies - perhaps 30 years for retirement but 10 or 15 years for a child's college education.
Step 2: Allocation
The three factors above help determine asset allocation - dividing your money among stocks, bonds, and cash.
The longer your horizon, the more you can afford to put into stocks.
"The best financial gains have come from stocks," says Larry Armel, president of fund company Jones & Babson in Kansas City, Mo.
Stocks historically have beaten inflation by seven to 10 percentage points a year.; government bonds by only two percentage points a year since 1926.
And remember: Over time, each annual percentage point adds up to lots of money.
Traditionally, long-term investors were urged to put 60 percent of their assets in stocks, 40 percent in bonds. But many experts now question that division.
James Fraser, of Fraser Management Associates, in Burlington, Vt., favors age. Put a percentage equal to your age in bonds, the rest in stocks.
Aggressive investors might tilt the balance even further toward stocks. You could take your age and subtract 20 to get your bond allocation.
Step 3: Picking funds
Now you're ready to actually pick a mutual fund or two!
How many to pick is a matter of debate. Most experts agree that a newcomer will probably only own a few funds. Balanced funds, for example, offer stocks and bonds together in one package.
Some advisers say to start with a "core holding," such as a growth-and-income fund that invests in large, blue-chip companies. Or an index fund that can mimic the entire stock market.
Then, as you add new money to your portfolio, add some new types of funds.
You will probably want to own a fund specializing in small companies, such as the Fidelity Low Priced Stock Fund (800-544-8888), and an international fund, perhaps Templeton World Fund (800-632-2301).
Neil Eigen, managing director of fund-company J.&.W. Seligman (800-221-2783), suggests putting at least 10 percent of your money in small-company funds.
On the bond side, consider an all-purpose bond fund such as the Loomis Sayles Bond Fund (800-633-3330), or Janus Flexible Income (800-835-1366).
A key concept is diversification, Mr. Eigen notes.
In a given year, not all fund types will move in sync. So by balancing foreign and domestic, small and large companies, stocks and bonds, you'll reduce volatility in your portfolio.
The charts that accompany this article show how one expert, Eric Kobren of FundsNet, spreads the risks.
After you've set your goals and allocation, make sure you do some research on specific funds.
First Steps on the Fund Track
Buying into mutual funds can be easy, painless, and profitable. A few steps:
* One-stop shopping. One fund family, such as Fidelity or Vanguard, gives you telephone access to many funds. Or, some discount brokers give you access to hundreds of different funds through one account. The biggest are: Jack White (800-216-2333), Charles Schwab (800-566-5623), and Fidelity (800-544-3025).
* Sign here. Once you've decided where to invest, it's like opening a bank account, but by mail: Call for an application. Fill it out. Enclose your check. That's it!
* So many choices. OK, you have an account, but what funds do you choose? Decide what types of funds meet your goals. Then narrow the list by comparing track records of individual funds and their managers.
* How much? Look at expenses. Some funds have "loads." That's an industry term for sales commission, a percentage of your money paid when you buy or sell shares in the fund. A "no-load" fund charges no commission. But they often charge yearly fees, called 12b-1, for promotional costs. All charge yearly management fees; anything above 1.5 percent of fund assets is considered high.
* Autopilot. You can arrange to invest a set amount each month in the funds of your choice. Ask the broker or fund how.
* Research. You can look at annual reports or prospectuses. Easier still: one-page fund reports prepared by Morningstar and Value Line, often available in public libraries.
* Hold taxes down by investing in an individual or employer-sponsored retirement account.