by Archie M. Richards, Jr., CFP^®
September 19, 2005

Here are four vital elements of good investing:

1. Save regularly, forcing you to live below your means: Save regularly, and make it automatic. Get the money working for the future before you touch it in the present. Ask your employer to take a cut out of your pay for investment. For your personal IRA or other investments, ask the mutual fund or brokerage firm to draw a fixed amount from your bank account every month.

   Set aside 10 percent of your gross pay. At $40,000 a year, we're talking $11 a day.

   Since budgeting is no fun, don't even try it; you'd probably knock it off within a week. Instead, set aside 10 percent of your gross pay and do whatever you must to accommodate. Live in a neighborhood where people have a standard of living you can easily afford. Go without soda and bottled water. Rent your movies. Buy nothing at the grocery store except what you list in advance. Buy a how-to-save book. Make saving a game.

2. Minimize the exercise of investment judgment: The most important aspect of investing is the reduction of risk. If you don't lose much and stay in, you'll win big.

   How to cut risk? By making as few investment decisions as possible.

   In the short term, everyone's investment judgment is lousy. Judgment is especially poor about what direction the stock will take. If you try to outguess it from month to month, you'll be wrong more often than right. Be wrong even once, and you'll never catch up with what you would have obtained had you'd just stayed in.

   But the long term is a different story. There, we know what's going to happen: Stock prices rise, because the people of the world keep creating wealth.

3. Be doubly diversified: To minimize the exercise of your investment judgment, be doubly diversified. Here's what I mean:
   • Don't buy individual stocks. Each selection requires investment judgment, which is a bummer. Individual stocks are much more volatile than the market as a whole. That up-and-down business usually spells L-O-S-S-E-S. Unless your employer gives you stock in a matching program, don't even buy your company's stock (unless of course you're the majority owner).

     Instead, buy and hold no-load index funds, which buy the stocks included in an index of a particular kind of stocks (like the Standard & Poor's 500 Index). They don't try to beat the index; they just try to equal it. By avoiding stock research and minimizing buying and selling, they save operating costs and capital gains taxes. The lower the costs, the more money you keep.

     Stay away from mutual funds with hot-shot managers who have a good record of beating the market. As soon as you buy such a fund, the guy's record will probably falter.

     That's the first level of diversification: buying index funds.

   • For the second level, spread your money among many kinds of index funds. You've got index funds of the stocks of Europe, the Far East, and Emerging Markets. For U.S. stocks, you've got index funds of big growth, big value, small growth, and small value. You've got index funds of real estate investment trusts and of long-term bonds. I count nine categories there: Buy 'em all. You may not have enough money to do so at first, but eventually you will. End up with 30 percent foreign stocks, 30 percent U.S. stocks, 20 percent REITs, and 20 percent bonds.

4. Rebalance: Check the values once a year - well, every year-and-a-day, to avoid short-term capital gains. (To keep yourself from taking foolish action, forget about them the rest of the time.) If one or two of the investment sectors has performed especially well, sell a portion and buy those that have done poorly. No investment judgment needed. Rebalancing is an automatic system of selling when they're high and buying when they're low.

   Save regularly, minimize investment judgment, be doubly diversified, and rebalance annually. Those are the four basics. Do them faithfully and over the long pull you'll be worth a million.