1. BE HUMBLE
When you do not know a thing, to allow that you do not know it--this is knowledge.
--Confucius
Investing is a big bet on an unknowable future. The mark of wisdom is accepting just how unknowable it is. Granted, that's not easy. Our brains are built to think the future will be like the near past. And we're too ready to act on the predictions of pundits, who are no more clued in than we are about what lies ahead.
Being humble in the face of uncertainty keeps you from costly mistakes. You won't jump on yesterday's bandwagon. And before you invest, you'll be more likely to ask a key question: "What if I'm wrong?"
2. TAKE CALCULATED RISKS
He that is overcautious will accomplish little.
--Friedrich von Schiller
The returns you get are proportionate to the risk you take. This is a fundamental law of the markets. It's why five-year CDs typically pay more than six-month ones and why you're disappointed if your emerging markets fund does no better than its stodgy blue-chip stable mate. History unequivocally supports this "no free lunch" principle. Going back to 1926, stocks (high risk) have paid more than government bonds (medium risk), which in turn have beaten low-risk Treasury bills.
Among many, many other things, this law suggests:
• To earn returns high enough to build true wealth, you have to put some of your money in risky assets like stocks--the only investment to handily beat inflation over time.
• If a financial salesperson tries to tell you his product offers a high return with no risk, get that claim in writing. Then send it and his business card to the SEC.
3. HAVE AN EMERGENCY FUND For age and want, save while you may; no morning sun lasts a whole day.
--Benjamin Franklin
The first step in constructing any serious financial plan is to create an emergency cash fund--ideally, three to six months' living expenses--stashed in a low-cost ultrasafe bank account or money-market fund. Without this financial cushion, any unexpected expense can derail your long-term plans.
These days, happily, that emergency stash won't just sit idle. Top bank accounts like the one at UFB Direct (888-580-0049) and perennially competitive money funds like Vanguard Prime (800-851-4999) now pay more than 5%.
4. MIX IT UP
It is the part of a wise man to keep himself today for tomorrow and not to venture all his eggs in one basket.
--Miguel de Cervantes
Nothing can break the law of risk and reward, but a diversified portfolio can bend it. When you spread your money properly among different asset types, a rise in some will offset a fall in others, muting your overall risk without a commensurate drop in return. It's the closest thing to a free lunch there is in investing. To make the alchemy work, you must load up on assets whose up and down cycles don't run in sync: stocks (both U.S. and foreign, as well as large-company and small), bonds (of varying maturities), cash, real estate and commodities.
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