Why am I investing? This is the first question that any investor should ask when deciding on a portfolio. My reason for investing is so that sometime between the ages of 40 and 50, my wife and I can build our dream home. We want a place in the country with some woods and lots of room for children and (especially) grandchildren to visit and relax. If there is still money left over, it will last until our mid fifties and aid in retirement.

How do I achieve that? Since that goal is 15 years off and also that it’s not something that will damage my life if I incur losses, I’m quite open to a healthy batch of risk. I want a strong portion in growth stocks, a smaller portion in a broad market fund, and a tiny sliver in bonds. Thus, here’s my desired portfolio:

30% Vanguard 500 (VFINX)
30% Vanguard Total International Stock Index Fund (VGTSX)
30% Vanguard Small Cap Growth Index Fund (VISGX)
10% Vanguard Long Term Bond Index Fund (VBLTX)

Right now, my balances are roughly as follows:

$5,500 Vanguard 500
$0 everything else

My goal, based on the previous fee structure with Vanguard, was to reach $10,000 in the Vanguard 500 and then move on to the other funds, but instead I’m changing that policy. I’m now saving, in an online savings account, the minimum needed to buy into the other funds one at a time, starting with the Vanguard Total International Stock Fund, and I’m leaving the Vanguard 500 alone and not buying any more for the time being.

So, here’s my fund-buying strategy for the next few years in order to build my portfolio:

First, save $3,000 in a high interest savings account and buy in on the Vanguard Total International Stock Index Fund. Once I’m in, I’ll make no additional investments until my initial buying is complete.

Next, save $3,000 in that same high interest savings account and buy in on the Vanguard Small Cap Growth Index Fund. Once I’m in, I’ll again make no additional investments until my initial buying is complete.

Then, to complete my initial buying, I’ll buy in on the Vanguard Long Term Bond Index Fund with again the minimal $3,000.

What then? Each month, I allot myself a certain amount to invest for our home, say, $500. I then look at the balances of all of the funds. Here’s an example of what it might look like when I’m all done in a few years:

$8,000 Vanguard 500 (VFINX)
$7,000 Vanguard Total International Stock Index Fund (VGTSX)
$5,000 Vanguard Small Cap Growth Index Fund (VISGX)
$3,000 Vanguard Long Term Bond Index Fund (VBLTX)

I then convert these to percentages of my overall portfolio:

34.8% Vanguard 500
30.4% Vanguard Total International Stock Index Fund
21.7% Vanguard Small Cap Growth Index Fund
13.0% Vanguard Long Term Bond Index Fund

… and I spend the month’s allotment on whichever fund’s percentage is the most below the desired percentage. In this case, that would be the Vanguard Small Cap Growth Index Fund, so I would invest the $500 in that. This changes the percentages to

34.0% Vanguard 500
29.7% Vanguard Total International Stock Index Fund
23.4% Vanguard Small Cap Growth Index Fund
12.8% Vanguard Long Term Bond Index Fund

Not perfectly balanced, but it’s closer. As time wears on, the percentages will gradually move closer and closer to my ideal portfolio.

Then, when the time comes, I cash them all out and my wife and I visit an architect. That’s the dream, anyway.

Right around that time (March 2, to be exact), Ben Stein posted a column at Yahoo! Finance entitled Keeping Your Cool In A Shaky Market. In short, the article basically encouraged readers to not sell like madmen because of the market hiccup, and actually offered some encouragement to buy.

On March 5, I took Stein’s advice and bought into the Vanguard 500, an index fund that matches the S&P 500 tightly. I bought shares in the fund at $128.89 a pop on March 5.

Yesterday, the Dow closed at a new all-time high, which reminded me that I had in fact bought heavily into a broad index fund just a little over a month before, so I went and checked the current value of a Vanguard 500 share. $135.67. In other words, my investment based solely on the principle of “buying low” saw a gain of 5.3% in a little over a month.

This doesn’t mean that I would buy immediately in every downturn, but that I saw no real reason for the previous downturn. There really is no sector that is truly overvalued right now (except possibly housing), so why would the market take a burp like that? As Stein points out, the market isn’t always rational. I saw it as a 5% off sale in the stock market, and a month later, it’s back to where it was.

So what did I learn from this?

My general investment principle is “buy low, sell when I need to.” I see no reason to really deviate from that general plan, and it seems to be working well. I generally buy a small amount each month (dollar cost averaging), but when there are opportunities like the one early last month, I’ll buy more. I also have no intention of selling anything until there’s a reason to sell it.

Watch what you invest. I keep my eye on what I’m invested in; I even have a spreadsheet that contains a bunch of data on the S&P 500 that I look at on occasion to see if there’s anything odd going on (like one sector bubbling up). For the most part, the numbers on this sheet have been roughly the same over the last year or two, and there’s no sign of a big bubble anywhere like there obviously was in stocks circa late 1999 and early 2000. I basically keep this as a “check” so that when there are little hiccups (or even big ones), I can feel fine buying in in the wake of the downturn, like I just did.

Don’t sweat it if you make a mistake. In other words, if you need the money to survive, don’t dabble in the stock market. I love seeing gains, but I also know that even if the market utterly collapsed, I wouldn’t be deeply worried because of that loss.

I don’t understand how the companies that run these funds make enough money to make it worthwhile after ads, expenses, and so on.

When you look at a mutual fund on Morningstar, you’ll see two key numbers: the expense ratio and the total assets. Multiply them together and you’ll get a pretty good sized number. Take the Vanguard 500, for example. It has an expense ratio of 0.18%, but it has $118,883,000,000 in assets. Multiply them together and Vanguard is netting $214 million a year out of the fund. Even with a small expense ratio, a fund can bring in a lot of money. An investment house does have a lot of expenses, but with that kind of money coming in, they can easily afford what they need to do and bring in some serious cash.

How do I balance a mutual fund portfolio if it’s invested in several different places?

The easiest way is to focus each account on a specific piece or two of your portfolio. This is especially easy if these investments are in 401(k) or Roth IRA accounts where you can move around the balance without incurring tax penalties. Sometimes an account won’t have enough in it to cover a single piece of your desired portfolio; in that case, you should finish out that piece in another account.

You keep mentioning capital gains tax. How do they work?

A capital gains tax is a tax that the government charges you when you sell an asset and make a profit on it. If you buy a stock at $10 and then sell it at $15, you have to pay capital gains tax on that $5 difference. Typically, capital gains tax are filed as part of your income tax return and are typically subject to a lower tax rate than normal income. More importantly, if you have a capital loss in a given year, you can subtract that loss from the gain and only pay taxes on the overall gain.

Sometimes you are subject to capital gains tax even if you don’t sell anything from a mutual fund. This is called turnover and occurs when a fund does a lot of selling of assets during a year without replacing these sales – they instead distribute the fund’s gains to the holders, putting them on the hook for capital gains. This distribution usually reduces the value of the fund, so it basically means that part of your investment can be handed right back to you and you have to pay capital gains tax on it.

Here’s an example of why turnover can be bad. Let’s say you bought $70,000 worth of a fund. It goes to $100,000. Two days later, the annual distribution occurs. You get a check for $30,000 and your fund’s value drops back to $70,000. You’re then on the hook for the capital gains tax on that $30,000 whether you like it or not.

One way to avoid this is to look for funds with low turnover, because those are much less likely to do a distribution (and thus cost you money).

Individual stock picking allows for massive and quick returns. If you invest in individual stocks, you give yourself the opportunity to pick the next Starbucks and ride all the way to the top, doubling or tripling your investment annually. This is simply not going to happen in a mutual fund.

Mutual funds hedge you against massive and quick failures. On the other hand, your individual pick might be the next Enron, which would mean bankruptcy. Investment in a mutual fund leverages this risk because you’re invested in a lot of companies.

Individual stock picking requires a lot of homework for success. Jim Cramer recommends one hour of research per week per individual stock holding, and I think that’s a pretty sound prescription if you want to see big successes.

Mutual funds require little research, but detach you from the day to day mechanics. With a mutual fund, it’s easy to get in, but it’s hard to really have a pulse on what’s going on with your investment. With an individual stock, you can just obsessively follow a certain company; with a mutual fund, it’s too broad to follow, so you just have to trust the fund manager.

Individual stock picking costs you on the buy-in and the sell with brokerage fees, but leave you alone once you’re invested. Thus, many small trades can eat you alive just with the fees, let alone the capital gains taxes. However, if you plan your moves carefully and have some strong money to invest, the fees become quite tiny in comparison.

Mutual funds generally cost nothing extra to get in, but slowly sip away expenses over time. Again, some careful planning can minimize this drain – get into an index fund that has a very low expense ratio.

So, which is better? Individual stocks are generally high-risk and high-reward but they require some serious footwork. Mutual funds generally have lower risk and don’t require as much homework, but they won’t get you rich in a few years. As for me? Mutual funds are the foundation; individual stocks are things to play with.

You can’t get exceptional growth from a mutual fund because the skyrocketing investments are held back by ones that aren’t skyrocketing. This is the big argument against mutual funds from the perspective of the individual stock investor, and it’s true: a single well-picked growth stock can utterly annihilate the gains from any fund.

They take a percentage of your money every year just for the “benefit” of holding it. Every year, a mutual fund takes a piece of your investment for their own – the expense ratio, to be exact. Other investments hold their original value without being slowly leeched.

The “success” of mutual funds is skewed by survivorship bias. In essence, survivorship bias means that the returns, on average, of an investment group’s mutual funds are higher than reality because investment houses kill poor funds quickly. They kill off all the bad ones and then average the ones that remain. Of course you can beat the market if you “cheat” like that.

Funds are marketed like anything else – and you pay for that marketing. You know the ads you see in magazines touting how great a fund is? You directly pay for them through special fees called 12b-1 fees. Not only that, the ads are designed to make the fund appear better than it actually is.

So why should you invest in mutual funds at all? They take your cash, stunt your returns, and lie to you about how great they are… why even invest in them? Well, each of these arguments has either a fatal flaw or a strong counterargument. Let’s walk through these one by one.

First, you can’t get exceptional growth from a mutual fund because the skyrocketing investments are held back by ones that aren’t skyrocketing. This is true, but you also can’t get exceptional loss from a mutual fund, either. Owning Enron individually would have bankrupted you, but owning a fund with Enron in it would have just been a little bump in the road.

Second, they take a percentage of your money every year just for the “benefit” of holding it. Obviously, someone has to put in the time to actually manage the fund and actively managed ones can be expensive, but you can really reduce this expense ratio by focusing on index funds. Many of them have expense ratios that are less than 0.2%, which in a fund like the Vanguard 500 that has returned over 12% over its history is really a tiny amount.

Third, the “success” of mutual funds is skewed by survivorship bias. Well, you aren’t investing in the entire offering of an investment house, so anyone that mentions survivorship bias is repeating talking points. It’s trivial to avoid survivorship bias by doing a bit of research; just find out what the numbers are on the fund you’re interested in and ignore such wide statistics.

Lastly, funds are marketed like anything else – and you pay for that marketing. Again, just do a bit of research and avoid funds that charge 12b-1 fees. Look at discount brokers and investment houses who don’t dump cash into advertising, like Vanguard, for instance.

In short, most of the big arguments against funds either have a good counterargument or can be avoided with some simple research.

Your first step is to figure out the percentages you want in each fund. This is a personal decision, but I would recommend for most people that they have at least 30% in fairly aggressive funds (I have 60% in my target portfolio) and at least 10% in something pretty conservative that will weather a bumpy ride.

For an example, I’m going to use the portfolio that I am shooting to achieve in the next three years for my home investments (which have a fifteen to twenty year timetable before I completely cash out):

30% Vanguard 500 (VFINX)
30% Vanguard Total International Stock Index Fund (VGTSX)
30% Vanguard Small Cap Growth Index Fund (VISGX)
10% Vanguard Long Term Bond Index Fund (VBLTX)

Next, figure out how much you need to actually build the portfolio. In other words, find out the minimum investment needed for each of the funds you’re going to invest in, then use that to determine how big your “starting” portfolio has to be. For me, all of the funds cost $3,000 to buy in, so that means I need a total investment of $30,000 to build that portfolio. In terms of starting dollar amounts, I need to look something like this:

$9,000 Vanguard 500 (VFINX)
$9,000 Vanguard Total International Stock Index Fund (VGTSX)
$9,000 Vanguard Small Cap Growth Index Fund (VISGX)
$3,000 Vanguard Long Term Bond Index Fund (VBLTX)

There’s another factor, though; Vanguard charges $2.50 a quarter for each fund you hold that’s under $10,000, and so I should start these $9,000 funds at $10,000. So here’s my actual position that I plan to start with:

$10,000 Vanguard 500 (VFINX)
$10,000 Vanguard Total International Stock Index Fund (VGTSX)
$10,000 Vanguard Small Cap Growth Index Fund (VISGX)
$3,500 Vanguard Long Term Bond Index Fund (VBLTX)

Once you’ve got the dollar amounts figured out, start investing in the funds. You’ll hear a lot of opinions on the order you should invest in. My feeling is that there should be one in your portfolio that you consider to be your “anchor” – not too risky, but not too conservative – and that’s the one you should start out in. For me, it’s pretty obvious – it’s the Vanguard 500.

I don’t have enough money to buy into the fund I want! Open up a high yield savings account, like one at ING Direct (the one I use) or HSBC Direct (another good one), and start putting money incrementally into that account until you can cover the minimum, then start buying the fund directly with those same increments until you reach your target. Then repeat the process with the other pieces.

Should I literally build a piece until I reach my target dollar amount? Some people might want to build a portfolio piece to near their target value and then move on to another. To tell the truth, either approach is fine. My plan is to build each piece up to their “starting” amount and then just let it ride while I build up other pieces. Once I have all of the funds with at least their starting amount, then I’ll do a rebalance soon after.

OK… what’s a rebalance? Let’s say I go through those investments in order and buy in to my target amount in each one. Obviously, I will have been invested in some funds for longer than others, and when I get done building all of my positions, hopefully some of the earlier funds will have grown a bit. Let’s say, hypothetically, that I finally get my portfolio built in December 2009 with a buy in on VBLTX and the balances look like this:

$13,500 Vanguard 500 (VFINX)
$12,000 Vanguard Total International Stock Index Fund (VGTSX)
$11,000 Vanguard Small Cap Growth Index Fund (VISGX)
$3,500 Vanguard Long Term Bond Index Fund (VBLTX)

My portfolio is now worth $40,000, so I’m really off to a good start here. But it’s a bit out of whack compared to how I wanted things based on percentage. My original goal was this:

30% Vanguard 500 (VFINX)
30% Vanguard Total International Stock Index Fund (VGTSX)
30% Vanguard Small Cap Growth Index Fund (VISGX)
10% Vanguard Long Term Bond Index Fund (VBLTX)

… but the actual percentages are now this:

33.75% Vanguard 500 (VFINX)
30% Vanguard Total International Stock Index Fund (VGTSX)
27.5% Vanguard Small Cap Growth Index Fund (VISGX)
8.75% Vanguard Long Term Bond Index Fund (VBLTX)

Switching back to raw dollars, I actually want is a balance close to this:

$12,000 Vanguard 500 (VFINX)
$12,000 Vanguard Total International Stock Index Fund (VGTSX)
$12,000 Vanguard Small Cap Growth Index Fund (VISGX)
$4,000 Vanguard Long Term Bond Index Fund (VBLTX)

To do that, I have to sell $1,500 in the Vanguard 500 and put $1,000 of it into the small cap fund and $500 in the bond fund. I just sell shares that minimize my capital gains tax incurred and reinvest it so that I again have my target portfolio.

When should I rebalance? To be honest, in reality, I probably wouldn’t rebalance that above portfolio. My rule of thumb is to check the portfolio every six months and if a holding is more than 5% off of my target, I rebalance it so that all funds are at or near the percentage I want. Basically, I just convert the entire portfolio to percentages (like I did above) and then compare each percentage to my target percentage. If there is a more than 5% difference, then I rebalance; otherwise, I let it sit.

Why? Basically, rebalancing leverages risk. At different times, some funds will outperform others – this just ensures that you can take gains out of funds that are very volatile and also buy in when some funds are underperforming. In other words, rebalancing is a way to buy low and sell high, at least in comparison to the rest of your portfolio.

Good luck!

The expense ratio The lower, the better. This is actually the biggest factor I look at, though not enough to swing me into investing in a fund with truly poor recent returns. Why? A fund with a low expense ratio is one that is looking for efficiency in investing, because many people merely look at returns. This means that when the market is bad and the actively managed and expensive fund is struggling, the efficient fund will have less baggage. You can find this info on the Morningstar.com page for the fund.

The five year return I basically view five year returns as the real short term, as I’m not in a mutual fund looking to maximize single year growth. Usually, a five year trend shows you most of one economic cycle, so you can get a rough idea of how it’s doing given the recent path of the economy. You can find this info on the Morningstar.com page for the fund.

The ten year return On the other hand, I also like the ten year return, which shows how it did over a full economic cycle (and a bit more). It shows me whether or not the five year trend is a fluke – if the two are far apart, I need to do some research before I invest. You can find this info on the Morningstar.com page for the fund.

The Morningstar rating I place a lot of trust in Morningstar’s rating, and I usually find it to be a nice thumbnail sketch of the state of the fund. I discussed this one in detail yesterday. You can find this info on the Morningstar.com page for the fund.

The investment philosophy of the fund I like to understand the ideology behind the fund: why do they invest the way they do? I like funds that primarily are on the lookout for shareholder value, but you may have different things you’re looking for (”green” investments and the like). You can find this in the fund’s prospectus, usually available from the investment house.

The turnover The lower, the better. High turnover funds might get nice returns, but they also hammer you hard on taxes. A high turnover usually the sign of a frenetically managed fund. You can find this info on the Morningstar.com page for the fund.

All other fees Before I make the leap, I make sure that there are no other fees or expenses that are hidden from my eyes. I do this by giving the site of the investment house a very thorough scouring for such things before I put in my money. I was literally obsessed with Vanguard for a period before finally investing with them. You can find this information on the website of the firm you invest with.

It’s also worthwhile to check out the full mutual fund prospectus before you invest, just to get a broader view of things. I previously wrote a guide to reading a mutual fund prospectus if the task seems daunting.

What is the “Money 70″? The Money 70 is a list of mutual funds selected by Money Magazine and followed in each issue of the magazine. You can read the full criteria for selection here, but the basic nutshell is that the funds on the list are generally low cost, focused on shareholder interests, and have a consistent investment strategy. It’s really a healthy list of well-run mutual funds from a variety of investment firms with a variety of goals and strategies.

Does this list match your investment philosophy? As I mentioned yesterday, I generally like index funds because they provide diversity without much expense; however, the Money 70 list contains 43 actively managed funds and only twelve index funds. In my opinion, the twelve index funds they show are stellar and the truth is that there are simply far more managed funds out there than index funds because lots of investors either want to beat the market or want a fund that is really conservative that won’t sink in a down market, two things that index funds don’t really protect you from.

I could repeat the contents of the list here, but a simple link to the Money 70 list saves the effort and provides a nice summary table. If you find a fund on that list that looks really interesting, I strongly recommend looking it up at Morningstar, as discussed earlier today.

What is Morningstar? Morningstar is a provider of independent investment research in the United States and abroad. They provide much of this information for free at morningstar.com. Basically, you can use this site to look up independent evaluations on any mutual fund you like – and other investments, too. Morningstar is so trusted that many funds will use their ratings from Morningstar in their advertisements.

Okay, so how do I use it? Hop over to morningstar.com and enter the name of a mutual fund you want to look at. For our purposes, I’ll take a look at the Vanguard 500 (here’s the Morningstar page for that fund in a new window). The first thing you’ll see is a boatload of information about the fund – an almost overwhelming amount to a beginning investor. If you’re overwhelmed, click on the “Data Interpreter” link on the left hand menu, which will automatically explain some of the data for you. I used the “Data Interpreter” heavily when I was just getting started with funds.

Information overload! What’s really important? The biggest things to look at when evaluating a fund with Morningstar’s data is to look at the “Key Stats” box in the upper right. The big things that I look at are the Morningstar Rating (which I’ll discuss below) and the Expense Ratio (which I like to be low). I also look at the trailing returns in the Performance section, but mostly at the five year trend.

What do the stars mean? Each fund evaluated by Morningstar is given a star ranking, from one to five stars, that evaluates the fund in a nutshell. If you want to understand how these stars are generated, Morningstar provides a strong explanation of what they mean. Generally, I don’t spend much time looking at anything below three stars, but if it’s three stars or up, I’ll look at it more closely (as many conservative and index funds are given three stars).

One bad thing, though… As you start to really get into the information provided, you’ll find that some of the neat stuff you want to look at requires a premium membership. What I did was make a lengthy list of things I wanted to look at, signed up for a 14 day trial of the premium membership, looked those up, then cancelled the service. It was worthwhile information, but I simply did not want to pay that much for a service I wouldn’t use with high regularity.

In short, Morningstar is a great place to look up fundamental information about a fund that you might see in an ad or hear about from a friend. It provides the real scoop without any bias.

First of all, I have two separate goals with my investments. The first is for buying a second home roughly fifteen years from now. Our first home, which we are in the process of buying, is going to be on the small side and both my wife and I want a larger home than the ones we are looking at so that we can have an invasion of grandchildren when we’re older. The second goal is an early retirement, targeting roughly twenty five to thirty years from now, so that I can be retired or very close to it when my grandchildren are born. These goals, as you can tell, have one big thing in common: family. My family is central to my life and thus my investments are geared toward them.

So, here’s my entire investment portfolio, using approximate numbers for values.

I have about $45,000 spread out between two separate 403(b) programs (for those unaware, 403(b)s are basically 401(k)s for people who work for a non-profit or for an educational institution). In both cases, this money is in that program’s version of the Vanguard Target Retirement 2040. When I establish my Roth IRA this year, I will be directly investing in that fund as well. Since my retirement goal is singular – I want to retire in roughly 2038 – I realized that I would basically be balancing my own fund with this retirement date as a target anyway, so why not just let them balance it for me? These funds have returned very well for me so far, and I anticipate watching them grow over time. I may make a small withdrawal from one of them, as it is allowed to aid with the purchase of a first home, but it will be less than 30% of the total amount I have in the funds.

As for that second house fund, I have about $5,000 in the Vanguard 500, which I selected because it is highly regarded, it has a very low expense ratio, it has a very long history of solid returns, and it is very easy to track and follow the holdings. I put in a specific amount each month that should have me on track to reach $10,000 in the account by the end of the year, at which point I will reduce my contributions. Why $10,000? It is a round target amount that puts me on a healthy pace, and at that dollar level, Vanguard eliminates a quarterly $2.50 fee on your balance.

Next year, I will complement this fund by buying into a much more aggressive fund, the Vanguard International Growth Fund. This one will basically determine how nice of a house we’ll buy when we’re 42. I feel strongly that globalization is just beginning, but I also feel that this is an event that can lift America’s boat if we place ourselves well – I intend to ride it a little.

Why Vanguard? In a nutshell, Vanguard treated me very well as a beginning investor and they have fund solutions for everything I want to do. I agree with their investment philosophies, their customer service is stellar, and I see no reason at all to jump to another investment house.

So, this is exactly where I stand in the middle of my twenty eighth year. Hopefully, a picture of one person’s real investments might give you an idea of what you could be doing with your money.

What is my goal with this money? If you’re thinking of investing money, you must have a vision for what you want to do with it. Do you want to buy your dream home in twenty years? Do you want to retire in five years? Do you want to quit your job in one year? Try to define a specific goal for the savings and also an approximate timeframe for that goal.

How far off is that goal? I generally sort people into three groups based on how far off the goal is: longer than ten years, one to ten years, and one year or less. If your goal is less than ten years, a mutual fund (especially one based in stocks) is probably not the best place to put the cash. If your goal is less than one year, I would actually leave it in cash and put it in a high-yield savings account.

Are you willing to devote a lot of regular time to your investment? For almost everyone, the answer is no, and if that’s the case mutual funds are probably the place to put your long term money. They take much of the time out of direct portfolio management.

As a general rule of thumb, the farther off your goals are, the riskier the mutual fund can be. If you’re looking at a forty year goal, having your money in things like an international small cap fund might be worthwhile because that fund could contain the next Microsoft, Cisco, and Google, but also might hold a Boo.com or two. However, if your goal is much closer (say, fifteen years), you probably want your cash in a relatively safe fund, like the Vanguard Total Market Index.

Here are some of the most common expenses that are associated with mutual funds. As a thrifty investor, you’re going to want to avoid these expenses as much as possible, so I’m also giving some tips on how to avoid the fees or at least minimize them.

Turnover This refers to buying and selling that occurs within a fund. Not only do these have their own costs (such as brokerage fees), but they also eventually cost the holder of the fund capital gains tax on all of those exchanges. In short, a fund with a high turnover can be really expensive to maintain, even if on paper it appears as though the fund has great gains.

How to avoid it Look for funds with low turnover. If you can’t find information about turnover on the fund, ask. Usually, most index funds have extremely low turnover.

Management fees Funds have to have someone managing them, right? And management has some costs associated with it, right? This is the portion that pays for the people actually doing the work to keep the fund running.

How to avoid it Index funds generally have little management effort required (as they’re composed of a publicly available list), so they usually have a very low management cost associated with them.

12b-1 and other service fees Often, funds charge additional fees for such things as advertising (that’s what 12b-1 fees usually cover), legal fees, registration fees, accounting fees, and so on.

How to avoid it Look for discount brokerages (like Schwab, E*TRADE, or Ameritrade) rather than full-service brokerages, or deal directly with the fund group themselves (like with Vanguard at vanguard.com).

In other words, a great strategy for a beginning investor to minimize fees when they’re just getting their toes wet in mutual fund investing is to buy an index fund directly from a management company. In fact, that’s exactly what I do, and I’ll discuss my investment choices a bit tomorrow.

A mutual fund is an agreement between a large group of individuals to invest their money collectively in any number of things. Generally, this involves each member giving some amount of money to a fund manager, who takes their money and invests it for them. The proceeds from this investment, minus expenses, are then returned to the original investor.

What’s the point? I can invest money on my own. That’s true, and many people with a substantial amount of money to invest perhaps shouldn’t bother with mutual funds – they should have their own investment manager.

However, mutual funds offer one big advantage that a smaller individual investor can never have: they allow you to be diverse without investing a lot of money. For example, let’s say you have $1,000 to invest. It is extremely difficult to make that $1,000 be truly diverse without spending your time managing extremely tiny investments. Even if you stick with just stocks, you’ll be in a situation where either (a) all of your money is in one or two stocks, meaning you’re carrying a pretty healthy amount of risk, or (b) the amount you have in each stock is so small that transaction fees will eat basically all of your investment, leaving you with nothing.

A mutual fund, on the other hand, can take $1,000 from 1,000 people and have a million to invest. With a million dollars, a fund can invest in a wide variety of investments without being eaten alive with fees and such.

How do I get my money out? Most mutual funds exist as shares, meaning that you buy a share in a mutual fund for a certain amount of money. As the value of the fund goes up, so does the value of the share. When you decide it’s time to sell, you can sell the share on the open market or, quite often, back to the company managing the fund.

If you have additional questions about how mutual funds work in general, don’t hesitate to ask a question in the comments, and also stay tuned this week for much more information on mutual funds.