This is the third installment of a series of blog posts about investing….the hows and whys. I originally posted  this series, with a few minor changes, at Daily Money Shot as a guest blogger.

As promised today’s post is about the S&P 500, the Dow Jones Industrial Average, and the NASDAQ.  It is important to know the difference between the three and also what they represent.

The S&P 500 is an index of the top 500 publicly traded companies.  “The index does include a handful (15 as of May 8, 2012) of non-U.S. companies.”

There is a committee that selects which companies are allowed into the 500.  The S&P 500 is “representative of the industries in the United States economy.”   This is very simplistic. There are weightings of the different industries, but for our purposes we just need simplistic.

One of the things you may hear about or read about is an S&P 500 Index fund.  What that means is that a mutual fund  was created to attempt to mimic the returns of the S&P by having the same stocks in their portfolio.  There are a lot of brokerage firms that offer an S&P index fund.

The Dow Jones Industrial Average or the Dow is quoted all the time in regards to the market.   “It is an index that shows how 30 large publicly-owned companies based in the United States have traded during a standard trading session in the stock market.”

The Dow Jones Industrial Average has very little resemblance to the Industrial in its name.  It was originally founded to measure the performance of heavy industry in America.  Now it is the go-to index to gauge how the stock market is doing even though it only follows 30 stocks, albeit large companies in their industries.

When I want to know how the market is REALLY doing I check the  S&P 500 ticker.  The DJIA ticker is a good indicator of the stock market movements but 30 companies do not make a market, in my humble opinion.

The NASDAQ is also an index like the S&P and the Dow.  Like both of them, the NASDAQ “is a statistical measure of a portion of the market.”

As with the S&P, you can have a mutual fund that tracks the NASDAQ.

I know this is very confusing to most people.  I have found one of the best places for no-nonsense definitions is located on About.com ‘s Budget and Personal Finance page.

I inserted a lot of links this time, but I wanted to give credit to the websites for the definitions I used, plus I am not as eloquent as a writer in defining the indexes.  I don’t want to give you the wrong information.

And besides, why re-invent the wheel?

I hope this brings a little more clarity to some more of those mysterious acronyms and words you hear bandied about.

Part 4 will bring some insight into Investment Style and what that means.

This is the second installment of a series of blog posts about investing….the hows and whys. I originally posted  this series, with a few minor changes, at Daily Money Shot as a guest blogger.

I briefly touched on mutual funds in my last post, but let me put it in layman’s terms:

A mutual fund is a professionally managed portfolio of different equities, such as stocks, bonds and cash, designed to give a small investor the opportunity to invest in those equities with a small amount of cash. 

The mutual fund manager takes the money you give him/her and decides the best way to allocate those funds.

If you are in a bond fund, then the majority of your dollars will be allocated to bonds.

If you are in a large cap mutual fund, then the majority of your dollars will be allocated to large cap stocks ie. McDonald’s, Kimberly Clark, Caterpillar, etc.  (We will discuss “large cap” at a later time.)

Also, remember the manager will not be fully invested. They will keep some money aside in cash for various reasons…sometimes because they sold off a position and just haven’t re-invested the cash elsewhere yet.

Different investment vehicles

When I was recommending mutual funds to former clients some of them would get so confused that an IRA they were invested in was actually a mutual fund just dressed up into a retirement vehicle.  Are you confused by that too?  Well, let’s see if we can remedy that.

*Note: for the more advanced girlfriend out there, I do know there are retirement vehicles that aren’t mutual funds, but for my purposes I am sticking with this view. 

You can purchase a “regular” mutual fund.  There are tax implications with a “regular” mutual fund.  When the funds you invested gain in value, which is the goal hopefully, then you will pay taxes on that gain when you remove the dollars from the fund.

Also, you will receive a 1099-DIV from your brokerage firm if your mutual fund invested in any companies that paid out a dividend that year.  You probably didn’t receive a check for the dividend payout because more times than not someone advised you to check the box “reinvest dividends.”  It is a very common practice unless you need the dividend income to live on.  It’s also a great way to increase your portfolio value.

Now here is the confusing part, I think.  Your “regular” mutual fund is great for some medium-term goals, but if you have long-term goals, as most of us do, your advisor has probably suggested an IRA.  That is an Individual Retirement Account.  The money you put into that account is intended to stay there until you are 59 ½.  The IRS will penalize you if you remove it prior to that age, unless you qualify for one of their exceptions.  There are 2 types of IRAs, the Traditional and the Roth.

• The Traditional IRA lets you deduct your contribution off your taxes which means this type of IRA is “tax-deferred.”  Since you didn’t pay taxes on your contribution you will pay them later along with paying taxes on all the earnings on said money.
• A Roth IRA, on the other hand, is not deducted off your tax return.  All the money you put into the IRA and all it earns are tax-free.  The penalty applies to both the Traditional and the Roth if you take the money out prior to age 59 ½.

One thing to remember, an IRA is either yours or your spouses’ (if that fits), hence the term INDIVIDUAL.  Even if you don’t have gainful employment outside the home, but your spouse does, you are eligible to contribute to one. I mention this because a lot of my girlfriends tell me that they have their husband’s IRA. Not so. You may be the beneficiary, but you are NOT the owner.

If you happen to be lucky to work for a company that offers a 401(k), good for you and even better if they “match.”   A 401(k) is another retirement investment vehicle.  You contribute to your company’s plan. The dollars you put in are considered a salary reduction.  In other words, you don’t pay taxes on that part of your salary.  This is another tax-deferred plan.

The last retirement vehicle to discuss is the 403(b). I inadvertently called it a 503(b) in my last post.  I’m sorry about that.  Acronyms and numbers trip me up too.  A 403(b) is structured very similarly to a 401(k) but it is offered to certain employees of public  schools, tax-exempt organizations and ministers.

All of the plans have benefits and you can have more than one of them at a time.  They do have different contribution limitations though.  If you exceed the limits, you will be penalized so consult your advisor, the IRS, or shoot me a note and I can discuss this with you.

There are even retirement plans for the self-employed, but the above 4 investment vehicles cover most of the population and their options.

To summarize:  3 of the plans I discussed are tax-deferred because you get to deduct the contributions from either your salary or your taxes and 1 of the plans is tax-free because you don’t deduct the contributions.

The next installment will discuss the differences between the S&P, Dow Jones, & the Nasdaq…stay tuned!

This is the beginning of a series of blog posts about investing….the hows and whys. I originally posted  this series, with a few minor changes, at Daily Money Shot as a guest blogger.

Like some of you, I didn’t know the first thing about investing.  All I knew was that my future husband went down to our local bank and opened an IRA (Individual Retirement Account) and I thought I should probably do that too.

The banker gave me some investment choices and I made my decisions based on those “stars.”  I even invested in the multi-national company that I worked for at the time.  They took $10 out of my paycheck every week to start my journey toward owning stocks.

Things changed for me, however, when I was finishing up my degree in business and I took a finance class.  I fell in the love with the concept of compounding interest…earning money on the interest earned.

The Birth of a Business

So let’s start at the very beginning of what I call the investing cycle…the birth of a business.  Most businesses don’t start out as large conglomerates.  Think Bill Gates and his garage here.  You (just as an example), and maybe a friend or 2, have an idea and decide to offer your product or service to those around you.  The idea takes off and more people want what you are offering.  You need a little more cash to either buy more supplies or to lease office space so you hit up Mom & Dad, your aunts and uncles, friends, neighbors, etc.  You ask them to loan you some money with the intent of paying it back with interest (more money than what you borrowed.)

Now the idea is really going and you know you need more cash for updated computer systems, maybe a truck, new tools, etc.  You get the idea.  You head to ABC bank.  They give you a loan (well, maybe not in this economy) and off you go to grow your business.

You are really cookin’ now!  And you need more money to hire salespeople, office staff, truck drivers, computer help, etc, but the bank isn’t interested in giving you more money.

So you reach out to what are called Venture Capitalists.  These are people or groups of people who are in love with your business.  They want to give you money.  Great!  The catch is that they want a “piece” of your business.  Let’s say they give you $200,000 to invest in the business but they want 25% of the profits.  So your business grosses (before taxes) $500,000 for 6 months, the Venture Capitalist takes their $125,000 in profits.

Make sense so far?

Your vision has changed and you want to go national with your idea, maybe even international.  Good for you and your success!

You decide you want to take your business “public” to raise even more money.  The Venture Capitalists aren’t going to be the only investors in your business any longer.  Large mutual funds will buy shares, as well as Mom and Pop.  You reach out to an investment bank to get your IPO (initial public offering) out to the public.  Once you are launched anyone can purchase a piece of your company.

And this is where “investing in the stock market” comes in for most of us.

We like a company or a product and we want to own a piece of it.  Most of us purchase what we think are pieces of companies through mutual funds.  Those mutual funds are dressed up into vehicles called IRAs or 401(k)s.  There are managers of those funds who decide which companies they want to invest in and what percentage of your money will go to each company.

Another example:  You give Ms. Money Manager of XYZ Fund $100 of your money.  Ms. Manager then invests in 10 different companies for you.   Now you “own” a piece of ten different companies THROUGH the mutual fund.  You don’t physically own the shares or the company.  Ms. Manager’s fund purchases pieces of the companies on everyone’s behalf and you purchase shares of the XYZ fund.  If you purchased some shares of your favorite soft drink company directly then YOU own the shares.

You still with me?

I think this is enough for you to chew on for now.

Not all businesses follow this exact trajectory, but it is safe to say a lot do.  I just wanted to give you an idea of the general process.

Next we will cover IRAs, 401(k)s, 503(b)s.  They sound scarier than they are.

As I always tell my girlfriends, you ARE smarter than you think.