Ten Things You Want to Know
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December 19, 2000
Every day, hundreds of emails flow into Fool HQ with questions about various aspects of investing and personal finance. Today we present Part Three in our series of the most common questions our customer service Fools answer. Below are 10 frequently asked questions and to the right are links to the two previous collections we've published. Read all three, and you may find answers to all your investing questions! If we don't cover your questions here, post a message on our Ask a Foolish Question discussion board.
- What is venture capital?
In a nutshell, venture capital is money provided to small businesses to help them grow. Financially, it's similar to a public stock offering, in that a company sells a piece of ownership in exchange for cash. The cash is then used to expand operations, build plants, hire employees, advertise, and so forth. In a venture capital situation, the money might be provided by a single person, a group of people, or a venture capital firm.
In most cases, venture capital firms also provide more than just money. They want to do the most they can to make sure their investment has the best possible chance of succeeding. Therefore they will often provide management assistance, contacts, and other high-level guidance and advice, as well as serve on the board of directors. Even so, many venture capital investments fail. Investors count on the one or two big winners to make up for the ones that don't do so well.
Joseph Richardson (TMFPhool1)
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- I'm wondering about United States Treasury bonds, bills and notes. What's the difference? Where could I actually buy bonds?
U.S. Treasury bills, bonds, and notes are debt securities issued by the U.S. Treasury Department. They are guaranteed for timely payment of interest and principal. Hence, there is no risk of default.
They are NOT guaranteed as to price changes resulting from interest rate changes and general market conditions. It is therefore possible to lose or make money when selling these securities before they mature. As maturities get longer, price fluctuations become more and more pronounced. All three are offered at auction by the Treasury Department's Bureau of Public Debt, and trade actively through institutions, such as banks and brokerages, and in the secondary market. All are now sold in "book entry form" and there are no actual certificates or interest coupons. The interest paid on these securities is not subject to state and local taxes under current rules.
Treasury bills, bonds, and notes are issued monthly at auction, although the maturities may vary. There is a regular notice (Uniform Offering Circular) available from the Bureau of Public Debt announcing upcoming offerings. In all cases the minimum purchase is $1,000.
Treasury bills are issued monthly with maturities of 3, 6, and 12 months. They are issued in discount form with the interest being paid at maturity. Treasury bonds and notes are issued on a regular basis, also at auction. Notes are issued with maturities of 2 to 10 years, the most common being 2, 5, and 10 years. Treasury bond maturities extend from 10 to 40 years. Interest for both bonds and notes is paid twice yearly with the principal being returned at maturity.
The Treasury has begun to issue inflation-protected bonds and notes in addition to the more traditional security. In these "inflation-indexed" securities the principal is adjusted for inflation on a regular basis. The second development is that the Treasury has begun to issue some "callable" bonds. That means that they are subject to mandatory redemption before they mature.
The three most common ways for investors to purchase Treasury securities are through a mutual fund, a bank or brokerage, or by direct purchase from the Bureau of Public Debt. There are now a number of short-, medium-, and long-term Treasury bond funds available to investors. Treasury money market mutual funds are also common.
Peter Lincoln (TMFBalder)
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- What is an index fund and how do I buy one?
In order to understand what an index fund is you also need to understand mutual funds and stock indices. A mutual fund is a pooling of investor cash that is invested on behalf of the investors. A stock index is a select list of stocks meant to measure some segment of the stock market. For instance, Standard and Poor's attempts to measure the entire U.S. stock market by tracking 500 stocks is called the S&P 500 Index.
An index fund is a mutual fund that holds the same stocks as a particular index, and does not actively manage its holdings. Because index funds are not actively managed, they can keep expenses very low. Lower expenses is one reason that the typical S&P 500 index fund has outperformed the majority of managed mutual funds in recent years.
Index funds can track any index, not just the S&P 500. There are index funds that track indices such as the Russell 2000, the S&P 600, and various industry-specific indices. In general, when we Fools use the term "index fund" we're referring to an S&P 500 index fund (unless we're Tom Gardner, who tends to favor a total market index fund -- an index fund that owns all the stocks on the major U.S. exchanges). For more information on different indices, see Question 4.
Many mutual fund companies now sell index funds. They have various minimum investment amounts and track various indices. To buy shares from a particular mutual fund company, call its 800 number, ask for an application, fill it out, and send in a check. If the company sells no-load funds, you won't even pay commissions.
You can also buy index funds through discount brokers, either by investing in index funds they offer (you will sometimes have to pay a commission to the broker even for no-load funds), or by buying exchange-traded funds such as S&P Depositary Receipts (AMEX: SPY), which are S&P 500 index fund equivalents. [More about exchange-traded funds in question 5.]
Patrick Keeler (TMFKeeler)
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- Which indices besides the S&P 500 are appropriate for investors?
There are many index funds based on many different indices from which to choose, with different returns and levels of risk (see our earlier question, "What is an index fund?"). Some indices can safely be used alone, while others are best used in combination.
Perhaps the best general index is the Wilshire 5000, often called a "total stock market index." This index holds over 7,000 stocks, and is the most diversified U.S.-based index. Investing in an index fund that tracks this index could be your sole strategy if you want to limit yourself to index investing. A possible shortcoming for some is that there is no foreign exposure.
A popular index for many is the Nasdaq 100, which tracks the top 100 companies in the Nasdaq stock market. This index is heavily weighted with technology issues, and includes some foreign stocks. However, keep in mind that, with only 100 holdings, the Nasdaq 100 can be quite volatile, and so should probably not be the sole element of an investing strategy.
An index like the Russell 1000, which tracks the 1,000 largest U.S. companies, is broad enough to offer diversity, but investors should be aware that it still does not include many smaller issues. People seeking a balance between growth and value might try investing along the lines of a combination of the BARRA/S&P Value Index and the BARRA/S&P Growth Index.
In sum, you can mix and match your investments as you choose. A novice can go with the Wilshire 5000, while more seasoned investors might choose to experiment with other choices.
John Saba (TMFOwl)
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