Empower Yourself with Finance Knowledge

Money

Everywhere you look today, thereare lists—bestselling books, mostwatched TV shows, highest-paidathletes, etc. Some lists, of course, containmore useful information than others.A recent issue of magazineincluded a list of the 101 things youshould know about investing. Can therebe that many, you ask? Yes, there are.I've taken the liberty of boiling themdown to these seven basics:

1. Allocate assets—Take advantageof the wisdom accumulated over theyears by people ranging from investinglegend Jeremy Grantham to everydayinvestors. At the heart of their advice isthe importance of asset allocation anddiversification. Spreading your investmentsover different types of stocks andbonds not only lowers the odds of losingmoney, but it also increases the odds thatyou will make money.

Also, don't sweat the fact that you'venever learned how to pick a stock. Thearticle suggests that if you put 60% ofyour money into a total stock marketindex fund and 40% into a total bondmarket index fund, in 10 years or more,you will outperform most individual andprofessional investors.

Consider:

2. Get started—There's no betterfeeling than knowing your money isworking for you. As such, take advantageof the power of compounding. Theearlier you start, the better. A30-year-old doctor invests $100 a monthfor 15 years and then stops. A seconddoctor, age 40, invests $100 a month for25 years. Who would have more moneyby age 65? The doctor who startedinvesting at age 30.

3. Know why—When it comes to stockinvesting, the article points out thatinvestors think of a stock as a share in abusiness they'd like to own for the longterm. If you can't cite some specific reasonswhy you're thinking about buying a stock(eg, its business strategy makes sense or itdominates rivals), maybe you shouldn'tmake the purchase.

4. Know what—Understand the differencebetween growth and valuestocks, the latter of which have slightlyoutperformed the former over the longhaul, providing a more reliable andmoderate earnings flow. Remember, too,that stocks come in all sizes, and it's notadvisable to put more than 10% of yourstock investment money into one company.Simply think of recent history withcompanies like Enron and WorldCom torecognize the wisdom here.

5. Consider bond basics—If you'reconsidering investing in bonds, rememberthe fundamental law that bond prices fallwhen interest rates rise, and vice versa.Also keep in mind that if you hold individualbonds until maturity, you will almostnever lose your money. However, you canlose money in a bond fund. That's becausethe value of the bonds in a fund's portfoliofluctuates based on interest ratechanges and other factors.

Money

Additionally, the article cautionsagainst putting tax-free bondsinto a tax-deferred retirement account.Doing so turns a tax-free investment intoa taxable one because you're taxedwhen you withdraw money from a taxdeferredaccount.

6. Be diverse—Remember the earlierpoint about the importance of diversification?That's what makes mutual fundssuch a good investment vehicle: instantand convenient diversification. But owning10 different mutual funds doesn'tmean you're diversified; many funds havesimilar holdings. To check if your funds'portfolios overlap, you can use the X-Raytool at Morningstar.com.

Be careful, though, how you use sectorfunds. According to the article, if youalready have a diversified portfolio, youprobably own a number of tech, healthcare, and financial stocks, so investing in asector fund that specializes in one of theseareas would throw your portfolio out ofbalance. A better move is to put a smallportion of your equity into a sector thatdoesn't tend to move with the rest of themarket (eg, real estate).

7. Obtain valuable advice—If you'relooking for financial advice, be awarethat you won't get it for free. The formof the fee—the commission on yourstock trade and fund purchases or thefee for developing a comprehensivefinancial plan—is not that important.What's important is that you knowupfront what the costs will be, and thatyou feel confident that you're gettingvalue for that advice.