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I was talking to a friend of mine the other day about investing. She just recently received her tax refund and had yet to “spend it” as she said. Naturally I suggested that she invest it. We got to talking about what she might invest her money in and since she has absolutely no investing experience I suggested that she might consider a mutual fund. She had heard of mutual funds before, but wasn’t exactly sure what they are. Of course I told her she should read my blog post about mutual funds, when suddenly I realized I didn’t have one. Thinking that it was really quite irresponsible of me to not have covered this topic as of yet, I am now going to right this wrong. Welcome to Mutual Funds 101.

What is a Mutual Fund?

A Mutual Fund is a diversified portfolio of investments… essentially a ready-made, specifically focused, investment portfolio. A Mutual Fund is a large pool of money which is used to invest in stocks, bonds or other securities. Mutual Funds are attractive to a large number of people because it is easy to purchase shares and they are great for investors who do not have the time or the desire to create their own diversified investment portfolio. Mutual Funds are usually geared towards one of three different goals: income, growth or a mixture of the two. An income fund invest mainly in - you guessed it - income investments such as bonds, preferred stock and income-oriented common stock (stocks that pay a high dividend). A growth fund invests mainly in high-growth (often small or mid-cap stocks) stocks and other types of growth investments. And finally the growth/income fund would invest in a mixture of these types of investments so as to provide a stream of income to the investor as well as potential for future growth.

How do I purchase a Mutual Fund?

To invest in a Mutual Fund is similar to investing in the stock of a company. Mutual Funds are sold by the share, just as stocks are. The Net Asset Value (NAV) of a Mutual Fund refers to the value of just one share of a Mutual Fund. This NAV is updated daily. Investors have two choices when it comes to investing in a mutual fund. They can purchase shares of the fund from the fund company directly or purchase shares through a brokerage account.

If you already have a brokerage account you might consider purchasing shares of funds directly through your brokerage, so as to keep all of your investments in one “place.” One thing to keep in mind is that some brokerages charge a flat fee to invest in a fund. This fee might make it more practical to purchase directly from the mutual fund company.

Some brokerages include E*Trade, Scottrade and Zecco Trading. Some great Mutual Fund companies include Vanguard and T Rowe Price.

Update: A great place to do research on mutual funds is over at Morningstar.com

Let me begin this post by saying that I am by no means a seasoned investor and my advice might not be as complete as someone who has been investing for 20 or 30 years. That being said I do not believe that investing is rocket science, and I do believe that the average Joe has the ability to earn returns on their money that can match - if not beat - the returns that the “professionals” achieve. Truthfully it’s really not all that difficult to do. There are just a few things one needs to remember when they begin investing.

• Investing is not gambling; luck should never be something that you rely upon when choosing an investment.
• Investment decisions should never be made without doing any research.
• One should never buy into a stock or fund when everyone and their grandmother is telling them how great an investment is and how it is going to make EVERYONE rich.
• Always diversify your portfolio (i.e. invest in more than one industry and/or stock type)
• Determine your level of risk tolerance (how much risk are you willing to take on?)

Choosing a stock to invest in requires first choosing a few companies in which you are interested, researching the companies and finally (this is the easiest part of all) purchasing the stock from your brokerage of choice.

Choosing a stock to research

The first step to investing would be choosing a few stocks each from different industries that you are interested in, or you could go about it by merely choosing companies that you do business with, determining their industry of business and finding out who their competitors are. For example let’s say that I am interested in the Oil Industry, the Retail Technology Industry and the Restaurant Industry. These are just three industries I picked off of the top of my head, but they do a good job of diversification considering that different economic events would not all have the same affect on these three different industries. Now that I have chosen a few industries I would want to think of a few companies that I know in these industries. For Oil I will choose Exxon Mobil (ticker: XOM) and Chevron Texaco (CVX). For Retail Technology I will choose Best Buy (BBY) and Radio Shack (RSH). Finally for Restaurants I will choose Cheesecake Factory (CAKE) and PF Changs (PFCB).

Researching your chosen companies

Now that I have chosen these few companies in each of my selected industries I would want to do some research on them and compare them to other companies in their same industry. This part is probably a little bit more time consuming than choosing stocks to research or purchasing them, but is also the most important step in investing. Just as a quick note, if you are not willing or do not have the time to do periodic research on your investments, such as reading earnings reports then stocks are probably not the best choice for you. If this is the case you might be interested in investing in one of the hundreds of mutual funds available out there. These funds are based on a diversified index of stocks such as the S&P 500 and would earn you the historic average of 8-9% a year.

Before we dig into research ideas I’d like to introduce you to a few of my friends, who if you are serious about investing will soon become your best friends also. My friends are finance.yahoo.com and moneycentral.msn.com. These sites should be all you need to do some basic research (and view results of research already completed) on your chosen stocks.

Because this is just a basic overview of investing and research I won’t go too deeply into the different methods of researching, but will instead just skim over some of more traditional and basic things to look up and compare. You’ll want to look up your companies P/E ratio, which means price to earnings ratio. Basically this ratio compares the current stock price of a company with its earnings. Traditionally the lower the number the more of a value the companies stock is, but this would not always hold true, for example P/E ratios between industries would not be a good thing to compare. As an example you would not want to compare the P/E ratio of Exxon Mobil (XOM) to that of the Cheesecake Factory (CAKE). Other things you can research and compare are sections of your chosen companies financial statements. It’s always a good idea to see how well the company is doing in bringing in revenue, how much debt they have and how well they are doing at paying it off and how effective they are at increasing revenues and decreasing expenses.

Let me just leave you with one other quick note on researching: I asked my friend Josh (who is a successful investor/day trader) if he had any advice other than what I’ve already mentioned and he mentioned how “you should never invest in a company that you don’t understand. If you don’t know how AAPL (Apple, Inc.) makes money or what their products are then you should not be investing in it… Research and then invest in companies that you understand.”

Purchasing your chosen stocks

Now that you have a good idea on how to choose companies and do a little bit of research on them you’ll want to open an investment account of sorts. The company that I used when I first began investing is Sharebuilder. I like a few things about Sharebuilder. I like that they make it easy to set up automatic investing plans, I like it that you can purchase stocks in dollar amounts instead of only per share price and I like it that their trading fees are extremely well-priced. It is for these reasons that I’m going to say that if you are just starting out then you might consider Sharebuilder. As you can see there is a large banner right below. As a disclaimer to you, my readers, I will let you know that if you click that banner and sign up for service with Sharebuilder and fund your account I will receive a commission. I do this to try and earn enough money to pay for my hosting and also because I’m hoping I’ll be able to raise enough to return some to you, my readers, in the form of contest prizes and what-not. We shall see how this second idea develops in the future. In the meantime if you disagree with providing me with some support by clicking on that affiliate banner please feel free to follow this link to Sharebuilder.

Also if you are not interested in Sharebuilder as much as a traditional broker you might try Scottrade or Etrade.

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I like to think that maybe I’ve learned something from all of the different mistakes I’ve made and also the things that I’ve done right. I haven’t done everything right, but I feel sincerely that for someone my age I’m doing pretty well. I have a high credit score and I have relatively little debt, all things considered. I am planning and contributing towards my retirement, and even towards shorter term things such as a down payment on a house. I feel like I’ve got a pretty good edge on things, although there’s still plenty that I could be doing better. Of course this got me to thinking about what I believe are the most important things that one can do in their “financial infancy” so to speak. Basically what follows is a quick list of some things that I believe someone just beginning adulthood and financial literacy should follow… a few rules of thumb, if you will.

Here’s what I’ve come up with:

1. Establish and maintain a positive credit rating
2. Learn to budget, and then to LIVE ON that budget
3. Learn to save(and not to immediately spend your savings)
4. Establish a 401(k) account, or if not offered establish an IRA or a Roth IRA

Joseph, you say, how can I do all of these things? A list doesn’t exactly tell me anything! Well my friends, let me dive just a little further into those points…

Establish a positive credit rating

Establishing (and maintaining of course) a positive credit rating will more than likely be one of the most important things that you will ever do when it comes to your finances. Truthfully it’s not difficult to establish and keep your credit rating (e.g. credit score) at an above-average level. The average FICO score is in the mid 600’s, something which can be achieved with just a little dedication. What sort of dedication? Not much. Truly. Pay your bills on time (this can be easily achieved with recurring online bill pay). Don’t max out your credit cards. Get credit cards if you don’t have any; use them monthly and then pay off the bill every month (on time of course). Be smart about your credit. Don’t open up a charge account at every store you shop at just because they are offering you 10% off today’s purchase. Don’t use your credit card to pay for something unless you have the cash to pay it off (or if you insist on using it still, make sure you’ll have the cash within a month to pay it off). Doing these simple things will help you to establish a squeaky clean credit rating, which will lead to lower loan rates and a much easier time qualifying for loans… not to mention potential auto insurance savings, etc.

For a little more detail on how a FICO credit score is calculated, and how it can be used, check out this post I previously wrote.

Learn to budget

Budgeting is an important part of your financial health. Budgeting means, in a nutshell, living within your means. It doesn’t necessarily mean tracking every single purchase you ever make and not allowing yourself to spend more than “x” amount of dollars on entertainment in a given month. Instead I have learned that it means to know how much you earn in a month and to not let your expenses exceed your income. Sure it sounds like a silly thing to say, but many people have yet to grasp this concept. Another thing I’ve learned that must be a part of ones budget is to budget a portion of your money away into some form of a savings or investing account. Go ahead, enjoy your life and spend your money while you still can, but make sure that you save just enough to cover emergency expenses and larger more expensive purchases, such as a down payment on a house or that new 52″ HDTV you have been lusting after. For a detailed look at a budgeting method I use, check out this post.

Learn to save

This one is pretty self-explanatory. Save a bit of every single paycheck and you’ll find yourself living much more comfortably than those around you. This principle is important for a few reasons. First it’s a good idea to have an emergency fund of about 3 to 6 months worth of your income saved up… for emergencies of course. Having this fund will erase untold amounts of stress from your life. Finally learning to save will eventually lead you to financial independence, and isn’t that what we’re all really after? Chances are you won’t be winning the lottery in this lifetime, so you’ve got to provide riches to yourself rather than expecting others to provide them to you.

Establish a 401(k)

For those who might not be informed on what a 401(k) is, please check out this post I wrote about it. I believe most of you probably have a pretty good idea of what a 401(k) is and what they can mean to your financial health at retirement. Contributing regularly to your 401(k) starting at a young age can mean all the difference in the world to the lifestyle you will be able to enjoy at retirement. If a 401(k) is not something that is offered by your employer (if you don’t know if it’s offered ask your manager - there’s a pretty decent chance that it is) then you will want to spring for an IRA or a Roth IRA. These are retirement accounts similar to the 401(k) in that they are tax-advantaged, but instead of being managed by your employer they are managed either by yourself or by a financial services company such as Vanguard. If you are in a low income tax bracket then a Roth IRA might be a better choice for you, because they are only taxable before the money is deposited into them. In other words when you go to withdraw from your Roth IRA at retirement you will not owe taxes on ANY of the monies that you pull out of your Roth IRA. Fantastic eh?

I defininitely believe that the above listed principles are very important to maintaining a strong financial health, and I also believe that only by being prepared and informed will you be able to become financially independent and probably even rich.

Do any of you have any other suggestions on things that you have found to be important when starting out your financial life? Or maybe something you wish you would have known - or done - when you were younger? Please leave your comments, and if you like this post feel free to share it with others.