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Q: I keep hearing about the Dow Jones Industrial Average (Dow 30) and the Standard and Poor's 500 (S&P 500) whenever people talk about how the stock market is doing. What are they and do they accurately reflect the stock market?

A. The Dow Jones Industrial Average dates back to 1884, when Charles Dow first began calculating the average stock price of eleven companies. Today, the "Dow" is made up of 30 widely held companies traded on the New York Stock Exchange (NYSE). Although referred to often, the Dow reflects the price movements of only 30 companies. Those 30 companies in the Dow are also very large companies. The S&P 500 is made up of 500 companies chosen by Standard and Poor’s to represent a more broad range of companies similar to that of stocks traded on the NYSE. Despite the much larger number of companies in the S&P 500 than the Dow, the S&P 500 still reflects the investment performance of only larger companies. Your retirement funds may be invested in firms too small to be included in either the Dow 30 or the S&P 500. These smaller companies will often have investment performance quite different than the large companies in the Dow 30 and S&P 500. This helps explain why your retirement funds may have returns which are different than the returns of the Dow and S&P 500. The Dow and S&P 500 only tell part of the stock market story, but they are the way America takes the pulse of the stock market.

Q: What is a mutual fund?

A: A mutual fund is an investment that pools your money with the money of many other people with similar investment goals. Professional money managers use the pool of money to buy securities that will help achieve the mutual fund’s specified objectives. Mutual funds may be an appropriate retirement investment because they offer professional management and diversification. Mutual funds are not FDIC insured and involve investment risks including possible loss of principal and fluctuation in value.

Q: What's an ETF?

A: An ETF is a flexible, useful trading and investment vehicle that consists of a basket of stocks that track an underlying index. They trade all day on an exchange, just like a stock, but they hold baskets of stocks (usually), just like a mutual fund. They’ve been around since 1993. The first ETF, the SPDRS (NYSEArca: SPY), tracks the S&P 500. The strategy of indexing is not new, however. Barclay’s created it in 1971.

Q: What Kind of investing strategy can be used with ETFs?

A: A simple strategy we suggest is to look for funds that are above their 200-day moving average. There are always areas that are trending up as others are going down. To learn more about this strategy and how to employ it, read our special report on trend following

Q: What do ETFs cost?

A: ETFs cost less, on average, than mutual funds. That doesn’t mean you should assume they all cost less. It’s important to do a little digging to make sure you’re getting the best price. Be aware that niche and specialty funds tend to cost a little more.
There are many uses and places within a portfolio to use an ETF, as well as specialized and specific roles they are now playing in markets. Use them with a firm strategy in place and with some knowledge and research they can do wonders.

Q: Why should I have a diversified portfolio?

A: Diversification or spreading your assets among a variety of investments helps to control the risk of poor performance by a single investment. A diversified portfolio increases your chances for achieving long-term growth. Keep in mind, however, that diversification does not guarantee a profit or prevent losses to your portfolio.