In the Dugout: Market, Indices, Diversification and Mutual Funds

What is the Market

The term market could mean different things to different people. Those that are hungry might think of a supermarket, but when we use the term market, we are referring to the stock market. There are three major stock markets where the majority of all U.S. stocks are traded; these are the National Association of Securities Dealers Automated Quotation (NASDAQ), American Stock Exchange (AMEX) and New York Stock Exchange (NSYE).

The AMEX and NYSE are actual exchanges located in a physical location. Even non-traders are familiar with the term Wall Street, which is where the NYSE resides. The NASDAQ is a computerized trading system with no physical location.

In general, it isn't that necessary to know which market a stock trades. This is because when a trade is place with your broker, either online or in person, it is routed to the best price, regardless of which market it resides.

What is an Index

An index is a way to see how the general market is doing without tracking every single stock that trades. The S&P 500 is the most popular index. This index tracks 500 stocks that are considered a good representation of the overall market. Another very popular measure of the market comes from the Dow Industrial Average. The Dow only tracks 30 stocks, but is still watched closely by traders. With the advent of computers, tracking larger basket of stocks has become much easier and the NASDAQ is an example of this. The NASDAQ is a group of thousand of stocks, mostly in the technology sector.

Indices are also developed for specific industries. This can be anything from utility stocks to Internet stocks. The idea being that we don't need to track every single stock in an industry to get an idea of how the sector is doing.

What is Diversification

One of the terms you will hear over and over as you talk to brokers and read articles about investing will be the term diversification. The idea behind this large word is to spread your investments among different types of securities and investment vehicles to lower your overall risk. It's basically the financial version of "don't put all your eggs in one basket."

Diversifying can be done in many ways and there is a plethura of ideas and views on how to best diversify. The idea of spreading your risk spawned one of the largest financial products ever, which is mutual funds.

What is a Mutual Fund

A mutual fund is where groups of people pool their money and then turn it over to a professional to manage for them. The genius behind the idea was it allowed the small investor to benefit from diversification. Though mutual funds have been around for decades, they really started to grow in the 80's.

Let's use an example to show why mutual funds have become so popular. Let's say you wanted to diversify your portfolio and felt that a basket of 100 stocks, bonds and CD's would do this. Now, all you would have to do is have the money to purchase the minimum amount of these products, as well as the expertise to pick the best ones available. See the problem? Enter the mutual fund. Companies started to allow individuals investments as low as $25 and then had a professional manage the money. Of course, the fund takes out a certain percentage for the service they provide. The idea caught hold and though its hard to believe, there are more mutual funds traded now than there are actual stocks.

Mutual funds are still a great way to invest for the long term and are the only way to invest in stocks in certain retirement plans. The nice thing is that there so many mutual funds now, you can buy one that is particular to a specific industry if you want.

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