Understanding Stocks

STOCKS: NOT YOUR ONLY INVESTMENT 25
join them. Therefore, if the Dow index is having a good year and is up
10 percent, you will get a 10 percent return on your fund.
Index funds are less expensive than other mutual funds because
you don’t have to pay an active manager and there are no extra sales
charges. For these reasons, index funds have become very popular with
the public. More than 50 percent of portfolio managers have failed to
beat the index funds (in some years, the records are even worse), and so
index funds are a popular alternative.
Keep in mind that in a bull market, index funds do well. During a
lengthy bear market, however, their performance will be terrible. (Bull
markets are markets in which the major stock indexes are consistently
going up because investors are buying stocks. On the other hand, bear
markets are markets in which the major stock indexes are consistently
going down because investors are avoiding or selling stocks.) Nevertheless,
the low cost and high performance of index funds have made
them attractive to many investors.
Cash
During the 1990s, putting your money in cash or a certificate of deposit
(CD) seemed like a dumb idea. After all, a CD, offered by most banks
and financial institutions, gave you a return of no more than 5 percent
a year. At the time, people became giddy when they saw the value of
their stocks go up by huge amounts. A 5 percent return on a CD seemed
like a bad joke.
The joke backfired, however, when people held their favorite
stocks too long. By the year 2001, the market had reversed. Many
investors who had held onto their favorite stocks lost nearly everything.
Those 5 percent CDs and an old-fashioned savings account (paying
only 1 percent a year) seemed like mighty good ideas. One percent a
year isn’t much—in fact, it’s a terrible return—but it’s better than losing
money.
If you have a preference for cash, you can also put your money in a
money market fund, which pays a little more than a bank. (A money market
fund is a mutual fund that invests in such short-term securities as CDs
and commercial paper.) You can also invest directly in U.S. Treasury bills,