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Glossary

Glossary

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I

IPO

Commonly believed to stand for "Initial Public Offering," or the first sale of a company's stock to the public. However, history shows that IPO can more accurately be said to stand for "It's Probably Overpriced," or "Imaginary Profits Only," or "Idiotic, Preposterous, and Outrageous." Because every once in a blue moon an IPO really does turn out to be Microsoft -- a stock that goes up more than 10,000% in a decade -- investors mistakenly conclude that every IPO is "the next Microsoft." That's like stepping into a casino just as a one-armed bandit vomits out a silver stream of coins and assuming that this particular slot machine has the best payouts -- or that it's worth playing the slot machine at all. Instead, as Prof. Jay Ritter's website (http://bear.cba.ufl.edu/ritter/ipodata.htm) shows, the typical IPO does worse than the average stock, not better.

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PORTFOLIO MANAGER

Imagine a chimpanzee who's got your money and won't give it back until you let him keep at least 1% of it.

PROSPECTUS

A legal document issued by a company that is selling securities to the public. Its purpose is to warn you that there is nothing secure about securities, thereby preventing you from suing the company if you lose money after investing. Anyone who actually read the full statements of risk in a prospectus would be too terrified to invest a dime -- thus proving that no one ever reads them. "Past performance is no guarantee of future results," declares the prospectus, right before it displays numbers glowing with the irresistible promise of a golden future. With this conflicted message -- you'd have to be crazy to invest with us, but everybody else who did got filthy rich -- a prospectus can only be likened to the beer ads that invite you to keep on chugging and "Please Drink Responsibly."

To be an intelligent investor, you must read a prospectus the same way you read any other financial document: From back to front, paying special attention to all the fine print and footnotes, and forcing yourself to confront the "risk factors" head-on. The stuff the company doesn't want you to know is almost always hidden in the back and buried in the tiny type of footnotes, and that's the very stuff you most need to know for your own protection. By U.S. law, a prospectus must be available for free download at the Securities and Exchange Commission's EDGAR website (http://www.sec.gov/edgar/searchedgar/companysearch.html). If you buy any security without carefully reading the prospectus first, you're not investing; you're walking onto a military firing range with headphones and a blindfold on.

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T

TURNOVER

The buying and selling of stocks or bonds by a fund's portfolio manager. The whole point here is to sell the bad ones (or the ones that are no longer cheap) and buy the good ones (or the ones that are still cheap). If the portfolio manager knows what he's doing, he will continually be removing stocks with low potential and adding stocks with high potential. Unfortunately, that's a big "if." First of all, if portfolio managers have really researched their stocks thoroughly, why do they hold on to their average share for only 11 months? If they keep changing their minds barely one year after they buy, they couldn't have done their homework very well in the first place, could they? Secondly, it costs money to buy and sell. The leading authority on transaction costs, The Plexus Group (www.plexusgroup.com) estimates that the typical U.S. stock mutual fund eats up roughly 1.5% of its assets every year through the high costs of trading. Turnover is like sandpaper: The faster and harder a portfolio manager trades, the more friction he causes, and the worse it burns. Finally, several authoritative studies have shown that funds would actually perform better if they had no turnover at all. As the old saying goes, "the faster they run, the behinder they get."

To find your fund's turnover rate, look in the "Financial Highlights" table in its annual report or prospectus. Under a heading usually worded something like "Supplemental data and ratios," hunt down "Portfolio turnover rate." It's expressed as a percentage. The typical US stock fund has a turnover rate of about 85%-six times what it used to be in the 1950s. To translate a fund's turnover rate into a number you can understand, divide it into 1200. That will tell you how many months the portfolio manager holds his average stock. Say a fund has a turnover rate of 107%. How many months does the manager stick with the fund's average stock? Easy: 1200/107 = 11.2 months. So this fund manager, who probably tells you in every annual report how he takes a "patient, long-term view of the markets," can't even stay put for an entire year.

Bond funds generally have a much higher portfolio turnover rate than stock funds, since bond funds must sell all their investments at maturity, while (in theory) a stock fund can hold its shares indefinitely.

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