Before you jump into stocks, cut your teeth on mutual funds
— -- A: Although you're a beginning investor, we can help you avoid a rookie mistake.
It's tempting when you're starting out to get sucked into the excitement of trying to pick individual stocks. You might think Ford is a can't-miss opportunity or that shares of Citigroup can't fall any more, since the bank seems to have the support of the federal government.
Both assumptions might be correct, or they might not. Even professional investors with years in the business are having trouble figuring out whether these stocks are undervalued.
And that's why, for investors just starting out, it's more beneficial to start with something less risky and over which you have more control. You can control your costs, your tax hits and your risk level. And knowing about each of these will better prepare you for choosing individual stocks.
When it comes to managing costs and taxes connected with investing, you want to understand how owning a broad diversified basket of stocks, such as an index mutual fund or an exchange-traded fund (ETF), can greatly reduce your both.
Because these investments spread your money over many stocks, you don't need to buy and sell as frequently. As a result, you can reduce both your trading expenses and the amount of money you end up sending to the tax man in capital gains tax. That's an easy way to be a successful investor right off.
Second, you'll want to learn about controlling risk. By carefully selecting broad baskets of different types of stocks, such as shares of small or large companies, as well as adding bonds to your portfolio, you can tweak your portfolio's expected return and risk. Asset allocation is a valuable exercise, since it lets you create a portfolio you'll be comfortable hanging onto for a long time.
Some studies have shown that asset allocation is more important to your returns than the specific investments you choose within each asset class. Here's more on that.
