SECTION 1: WISDOM
1: You have an advantage over the pros. Professional money managers are judged by whether they beat the market from quarter to quarter. They don't always have the luxury of holding on -- or buying more -- when a stock tanks. But there's no such scrutiny of your performance. When the markets go crazy, you can simply sit tight, calmly focusing on the long term. As the great investor Benjamin Graham said long ago, that is the "basic advantage" that individuals have over the pros. Use it!
2: Asset allocation is more important than trying to find the next Microsoft. Over long periods, the returns you get on your stock and bond investments will tend to match the historical averages, so the key factor in your results will be how much of your money you keep in stocks and how much in bonds. Once you've made that decision, you can focus on picking specific stocks, bonds and funds.
3: You can retire comfortably without ever learning how to pick a stock. Put 60 percent of your money in a total stock market index fund and 40 percent in a total bond market index fund, and over 10 years or more you will outperform most individual and professional investors.
4: All investing involves taking risks.
5: Diversification is the wonder drug of the investing world. Spreading your investment stake over different types of stocks and bonds lowers the odds that you will lose money -- and raises the odds that you will make money.
6: Over the long term, stocks have returned more than bonds, and bonds more than cash. That doesn't mean they always will.
From 1926 to 2003, according to Ibbotson Associates, stocks have had average annual returns of 10.4 percent, bonds have had 5.4 percent, and cash, 3.8 percent.
7: Remember regression to the mean. Athletes, a superstitious bunch, call it the "Sports Illustrated cover jinx" -- the tendency of sports stars to fall into major slumps after taking a turn as a cover boy or girl. The same thing happens with hot companies: Amazon's stock still hasn't recovered from CEO Jeff Bezos' turn as Time's 1999 Person of the Year. But as mathematician John Allen Paulos notes, what looks like voodoo is often little more than regression to the mean. Investors tend to get excited about companies that have had periods of exceptional out performance -- the equivalent of flipping "heads" 10 times in a row. But no one can defy the odds forever: Even the fastest-growing companies tend, over time, to revert to growth rates closer to their industry average. Think twice about paying extra for those high fliers.
How to time the market -- and how not to
8: Don't pull money in and out of the market trying to catch highs or lows. Researchers have yet to find a single measure that correctly tells when the market has hit a top or reached a bottom. They probably never will.
9: Dollar-cost average. Investing a fixed dollar amount every month or every calendar quarter is the single best way to strap yourself in and stay the course.
10: Rebalance. Let's say you want 60 percent of your money in stocks and 40 percent in bonds. If stocks go on a tear and amount to 75 percent of your total portfolio, sell enough of them to get yourself back to 60-40. That way, you'll always sell a little of what's become more expensive and buy what's become less expensive. It's an automatic way to buy low and sell high.
11: Earning a high return requires taking more risk, but taking more risk doesn't necessarily lead to a higher return. It's only natural that high-return investments are linked to higher risk. Without the lure of loftier gains, we'd never venture beyond the most secure investments. But that doesn't mean we always get the bigger gain we expect. During bull-market feeding frenzies, we may lose by grossly overpaying for a stock. Or the company we saw as a winner may simply crash and burn.
12: You can't know how much risk you can tolerate until you've tasted real losses. Like love or a bad case of food poisoning, risk is something that is hard to understand in the abstract -- a harsh fact that the Nasdaq crash brought home to countless tech investors who thought themselves invulnerable.
13: There's more to the stock market than the Dow. The Dow Jones industrial average contains 30 of the largest, most familiar companies in the U.S., encompassing all sectors except utilities and transportation. Standard & Poor's 500-stock index includes 500 companies spread over more industries. As a result, the S&P 500 has become the measuring stick of choice for investment professionals. Other indexes include the Nasdaq composite, which contains all the companies traded on the Nasdaq; the Wilshire 5000 total market, which now contains more than 7,000 stocks that trade in the U.S.; and the Russell 2000, which measures the performance of smaller stocks that are typically excluded from other indexes.
14: The rule of 72. A handy trick to approximate how long you need to double your money: How many years will it take to turn $1,000 into $2,000 at 8 percent? Just divide 72 by eight to get nine years.
How to make your money work for you
15: Tap into the power of compounding. If you earn 6 percent on a $1,000 bond and spend your interest every year, after 20 years you will have received $1,200. But if you can reinvest your interest at 6 percent, you'll net $2,262. That's the power of compounding -- your profits make profits.
16: Start early. With compounding, the more time you give it, the better it works. Here's an example: Let's say one person invests $100 a month for 15 years starting at age 25 and then stops adding money to his stake. Another person puts away $100 a month for 25 years starting at age 40. Which one ends up with more money at age 65? The early starter, by far.
17: Save more. Another way to tap into the power of compounding: Put away a few more dollars each month. Over time, those dollars will turn into thousands.
18: When planning for long-term goals, assume that your overall portfolio will earn 5 percent to 6 percent a year.
19: Some things are best left to the pros. It is almost impossible for an individual to make money in the commodities markets. You are up against professional traders with far more knowledge than you have, and the costs of buying and selling are enormous.
20: When you buy a stock, you think it'll be a winner. But you're buying it from someone who's happy to let it go.
21: Don't rely on the regulators. Sure, asleep-at-the-switch regulators deserve at least some blame for the recent stock and fund scandals. But even as the Securities and Exchange Commission scurries to make up for lost time -- and to keep up with a certain ambitious attorney general from the State of New York -- investors need to be realistic about what the government can and can't do. Regulators can certainly be more aggressive in rooting out fraud and forcing companies to disclose more and better information. But the plain fact is that investors haven't always made good use of the information they already have at their disposal. How many investors really read the risk statements in IPO prospectuses before making their bets? No amount of regulation can force investors to behave prudently -- or keep markets from going down.
22: Never let tax considerations be the main driver of an investing decision.
23: Nothing tops the 401(k). It's a triple threat: You don't pay taxes on the money you contribute, and you get matching funds from your employer and tax-deferred growth. No other investment offers that potent combination.
24: Watch what you watch. Want to increase your returns? If you find yourself in front of a TV in the middle of the day, don't flip over to the business channel. You really don't need to know what's happening to semiconductor stocks at 2:37 on some random Tuesday afternoon. Watch Oprah, or the Jerry Springer Show, or VH1 Classic instead. No, you won't get any good investing insights, but at least you won't be tempted to trade -- a surefire way to increase your investing costs and weigh down your returns. The biggest risk? That the Springer show so erodes your faith in humanity that you pull all of your money from the market and hole up in a cabin in the woods.