A Beginning Investor's Best Friend

So you want to start investing. But every time you think of dipping your toe in the pool, you feel as if you're drowning in a flood of investment choices and stock market terminology.

You don't have to be an economics major to invest your way to riches. Allow us to introduce you to your new best friend, the mutual fund. These investments are simple to understand, they can make you a lot of money, and you can get started investing this afternoon if you want. To top it off, you don't have to be rich to buy into one.

If you've ever pooled your money with your friends to buy a few pizzas and drinks, you understand the concept of mutual funds. They combine several investors' money to buy a variety of stocks that may be too expensive for the individual to purchase alone. This allows you to diversify your investments (you can get pepperoni, ham and pineapple, plus sausage and olives) while keeping costs low.

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Plus, with a mutual fund, you're basically hiring a professional to manage your money and pick stocks for you so you don't have to wade through all those corporate financial documents on your own. Even if you have the brainpower and patience for that, who has the time? With just one fund, you can own dozens of stocks so you're not betting the farm on the performance of one company. Everyone who owns the fund, no matter how much or how little they have invested, gets the same manager, investments and return.

Are you ready to invest?

If you're reading this article, you probably already know that investing your money is the path to wealth. For example, if a 25-year-old invests only $158 a month ($1,900 a year) and earns an average of 10% annually on her investment, she'd have a sweet million saved by the time she retired. Use this calculator to see how far your investments can take you over time.

With numbers like that, who wouldn't be eager to get started? But before you plunk down a dime on any investment, you need to make sure you have an emergency stash of cash and you've paid off your high interest debt. Also, if your employer offers a match on 401(k) contributions, you should participate in that first or else you'd be passing up free money.

Next, you might wonder if you even have enough money to invest. If you can rustle up a spare $50 a month, you can buy into a top-notch mutual fund right now. That's the minimum amount a handful of mutual fund companies will let you in for if you set up automatic deductions from your bank account or paycheck. Those companies include Ariel Mutual Funds, TIAA-CREF and T. Rowe Price.

That low $50 minimum applies for IRA accounts, which are a type of account in which you park your funds. We like Roth IRAs and think every young person who qualifies would do well to start investing in these tax-sheltered retirement accounts as soon as possible. You can learn about all there is to love about the Roth in Why You Need a Roth IRA. If you choose to hold your funds in a regular taxable account, you're typically held to higher minimum investment requirements that can run anywhere from $1,000 to $3,000, and you'll have to pay taxes on your earnings.

Of course, investing $50 a month is just the starting point. The key is to increase your investment as your paycheck gets bigger.

But which fund?

So now that $50 is burning a hole in your pocket, where exactly should you put it?

Fund managers just don't go out and pick investments with your money willy-nilly. Each mutual fund has a "style" or "objective" that its manager must stick to. So the trick on your part is to find a mutual fund that buys the kind of investments you want and sticks to a style you're comfortable with.

A great place for beginning investors to start is with a mutual fund that invests in a broad range of stocks and investing styles because you don't want to put all your eggs in one basket, so to speak. For instance, T. Rowe Price Spectrum Growth (symbol PRSGX; 800-638-5660) is a single fund that invests in ten other T. Rowe Price funds. Spectrum Growth has an annualized return of 9% over the past ten years, 6.7% over the past five years and 14.5% over the past three years. Investors pay only the expenses of the underlying funds; investing $600 a year will cost you only $5 in fees.

Another one-stop choice is a target fund. Managers of these investments assemble a diversified portfolio of stocks or funds for you and automatically tone down your risk as you approach your target date. This means you can pick one fund and let it ride. Letting you in for $50 is T. Rowe Price Retirement 2040 (TRRDX). The fund, which was launched in 2002, has returned an annualized 13.5% over the past three years. If you have a little more seed money to start with, Vanguard's Target Retirement and Fidelity's Freedom funds are also solid choices. Vanguard (800-635-1511) requires a minimum $3,000 to invest, and Fidelity (800-544-8544) requires $2,500.

Or, you can forgo the hands-on manager altogether and invest in a so-called index fund. The fact is that over the long term, few mutual funds perform better than the overall market, so if you can't beat 'em, why not join 'em? For example, with T. Rowe Price Equity Market Index (POMIX) $50 a month essentially buys you the entire U.S. stock market -- how's that for diversification? See The New Spin on Indexing to learn more about index funds. (Vanguard and Fidelity are also known for their top-notch and low-cost index funds, but you'll need a bigger initial investment to buy in.)

Once you've selected your fund, all you need to do is log on to the fund company's Web site and follow the instructions for opening a new account. Many firms allow you to electronically draft your bank account for your initial deposit, and we think that setting up automatic deposits is a great way to put your investing on autopilot -- you won't have to remember to write a check each month, and by investing regularly you'll smooth out the volatility of your portfolio over time. Or, you can simply call the firm and tell them you want to invest.

Take it to the next level

Once you're getting the hang of investing and you think you might want to branch out a bit, check out Kiplinger's discussion of the 25 Best Mutual Funds. The list includes funds that invest in the U.S. stocks, international stocks and bonds. View our sample portfolios to see how to combine our recommended funds to reach your specific goals.

You can also use Kiplinger's Fund Finder to look for investments that meet your criteria, including those with low minimum requirements and those that meet certain performance standards.