Tuesday was the one year anniversary of the 2009 U.S. stock market low¹.

The market peaked in October 2007, then fell 53% over the next 17 months, hitting a low on March 9, 2009. From that low the market has risen 67%. It's still off its peak by some 22%.

Down 53%, up 67%, what a rollercoaster ride!

Investors can potentially make such rides less damaging to their portfolios by following some principles in our free investment guide:

#1 Don't panic. Don't sell just because the market is down. Stick with a buy and hold approach to investing.

#2 Continue to save. Even in tough economic times, cut back enough on spending to keep saving a little each month.

#3 Continue to invest additional savings in stocks and bonds as appropriate for your time horizon, risk tolerance and financial needs. Consider investing money you won't need for several years in stocks, buying additional shares at potentially lower prices as the market goes down.

Following these principles - buy and hold, save aggressively and invest long term money in stocks – can potentially help an investor ride out stock market ups and down. Being someone who eats their own cooking, these are the things I have done with my own money.

¹ As measured by the S&P 500 Index. Returns are total return with dividends reinvested.

One of our firm’s Four Core Principles is that trying to guess when the market will go up or down – and buying and selling your investments based on your prediction – does not work.

If there was ever any doubt that market timing doesn’t work, the last couple years puts that question to rest.

The stock market declined throughout 2008 and into early 2009, then rose through the remainder of the year.

An investor that just held their stock investments through that rollercoaster ride did twice as well as those who sold as the market slumped and then bought again as the market went back up.

As a New York Times article recently pointed out:

“From March 9 [2009], when the rally began, to December 17, the S&P [500] advanced nearly 65%. But if you sold out of your stocks during the 2008 downturn and came back into the market less than a month after the rally started – say, on April 1 – you would have earned a 37% return.

“In other words, you would have missed out on 40% of your potential return.”

And it wasn't just this time around.

Over the last 30 years, if you missed the 10 best days in the stock market you would have lost over 50% of your potential return¹. That's just 0.02% of the more than 7,500 trading days in that period.

As history points out again and again, time, not timing, is the best way to capitalize on the stock market's gains.

¹ Source: S&P 500 Index, 1/1/79 - 12/31/08. Data is historical. Past performance is not a guarantee of future results.

If you enjoyed our Keep It Simple Guide To Investing, you're going to like this.

We've recorded a brief 9 minute webcast that covers all the information in the Guide, but in a full multimedia presentation.

You can view it here.

We thought it would be great to take the Guide and make it come to life as an online webcast.

You can stop, pause and replay sections at your own pace, on your own schedule.

I'd like to hear your feedback after you watch it.

I encourage people to focus less on what individual stocks, bonds and mutual funds to buy and to focus more on what investment categories to buy.

More than 80% of your investment return could be determined by how much you put into stocks versus bonds and what categories within each of these that you choose.

Putting more in stocks (average return 10.4% per year) than bonds (average return 5.7% per year) may produce higher returns than putting most of your savings in bonds and very little in stocks.

Going further, within the stock category how much you invest in large U.S. companies (average return 10.2%) vs. how much you invest in small U.S. companies (average return 12.2%) will also decide a lot about your final results.

Notice here that we are not discussing yet individual stocks, bonds or mutual funds. We're focused on the mix of investment categories first and foremost.

The mix also affects the risk you take on.

Stocks tend to go up and down more drastically than bonds. Among stocks, large company stocks tend to be more stable than small company stocks.

Below is a menu of typical investment categories that an individual might choose from:

- U.S. Government Bonds
- U.S. Company Bonds
- U.S. Large Company Stocks
- U.S. Small Company Stocks
- International Stocks
- International Bonds

In our Keep It Simple Guide To Investing we outline a possible mix of these categories and some funds to buy that represent these categories well at a low cost.

There is no single mix that fits everyone. But our suggestions provide a solid long term, broadly diversified mix of the key categories that should be a part of an investment portfolio.

Today any investor can build themselves a world class portfolio at a low cost regardless of how much they have to invest.

Even with only $1,000 in an IRA account, the individual investor can build an investment portfolio that rivals someone who has $1 million and help from a professional money manager.

All you need are some well chosen, low cost index funds and some basic calculations about what money you will need and when.

As explained in 80% of Investors Get It Wrong, index funds can provide investors with broad diversification and superior returns compared to picking individual stocks or hiring a mutual fund manager to pick stocks for you. In a single index fund it's possible to own, for example, the entire U.S. stock market - all with one $10 trade in your brokerage account.

And with a small collection of index funds, you can own most of the world stock and bond markets, diversifying across countries and industries and investing in both large and small companies.

The keys are to select the right index funds that are low cost and broadly diversified and to allocate your savings appropriately based on your financial goals.

In terms of allocating your savings, in the Keep It Simple Guide To Investing we suggest:

1. Set aside a cash reserve for emergencies in an amount equal to 6 months of living expenses.

2. Invest any money you need within the next 15 years in bonds.

3. Invest the balance of your savings in stocks.

The Guide explains in further detail the reasoning behind this advice in straightforward, easy to understand terms, then lists specific funds that you can buy which will deliver solid long term returns at a low cost.

So whether you have $1,000 or $100,000 in savings to invest, there is no reason you can't have the same world class investment portfolio as the wealthiest among us.

In my last post, Stocks Win In The End, I made the case for stocks being the best long term investment. Stocks beat all other investment types in the long run, averaging a 10% annual return.

The question that follows is, how best to invest in stocks? It's an important question since 80% of investors are getting the answer wrong.

Let's walk through the options when it comes to stocks:

Option #1 – Stock Pick

Research and buy stocks of individual companies that you think will do well in the future. You're betting you can do a better job than most investors, including professionals that have multimillion dollar research departments and a team of analysts.

Option #2 – Hire Someone To Stock Pick For You

You realize that you don't have the time or knowledge to pick stocks yourself, but you figure a professional money manager should be able to do pretty well. So you either buy stocks based on recommendations from an advisor or you invest in a mutual fund that picks stocks for you.

The problem with option #2, much like the problem with option #1, is that it is very hard, nearly impossible, to "out pick" the market.

Morningstar, the research company that tracks mutual fund performance, says that 7 out of 10 stock mutual funds fail to beat the overall market each year. And the 3 out of 10 that do beat the market change from year to year.

Why can't even professional money managers beat the overall market average? Fees and taxes.

Mutual fund managers buy and sell stocks a lot searching for the best return. The frequent trading costs money. A recent study suggested it could wipe out 10% of the fund's gains.

The average stock mutual fund also charges, according to Morningstar, a management fee of 1.35% of your investment every year. So if you are hoping for a 10% annual return, the fee just ate up 13.5% of your profit. Tack on the trading costs and now almost 25% of the fund's annual return is eaten up.

Finally, all that buying and selling generates capital gains on which investors have to pay taxes each year, further reducing after tax returns.

Option #3 – Buy Everything

Which brings us to the last option, the one I suggest, but the one only 20% of investors follow.

Give up the notion that you or last year's 5 star mutual fund manager can outperform the market. You can't, and they can't, over the long term.

Instead, own the whole stock market. Through an index fund you can buy a piece of nearly all stocks in the market - essentially owning everything. There is no stock picking, so trading costs are minimal, which means potential capital gains taxes are small.

In addition, since an index fund doesn't need all those high priced money managers and research departments to select stocks, the management fee is typically 60-90% less.

A well diversified index fund will get you a return each year that closely matches the overall market. You will typically outperform around 70% of mutual fund managers year after year.

In our Keep It Simple Guide To Investing we suggest some index funds to invest in to follow this strategy. Download a free copy and consider how this investment approach might meet your needs.

Owning businesses and sharing in their profits – in other words owning stock in companies – produces the best return for investors over the long run. Properly diversified across industries, geographies and company sizes, stocks have historically outperformed other investment types.

Historical Annualized Return

Stocks – 10.4%
Real Estate – 8.3%
Bonds – 5.7%
Gold - 4.7%
Cash – 3.7%

Source: Stocks, bonds and cash: Ibbotson Associates, historical data 1926-2008. Stocks are 80/20 split of U.S. large and small companies, bonds are intermediate term U.S. government bonds and cash is 3 month U.S. Treasury bills. Real estate: "The Equity Risk Premium," Goetzmann and Ibbotson, 2006. Gold: Global Financial Data, historical data 1926-2008.

Stocks More Risky?

But aren't stocks more risky than, say, government bonds or bank CDs? In one sense, yes. In another sense, no.

Yes, owning stocks carries more risk in that prices are more volatile, so the value of your investment can go up and down unexpectedly. Stocks, for example, lost close to 40% last year. But for the long term, buy-and-hold investor stocks eventually revert to their superior returns over other types of investments.

By another measure you could also argue stocks are the least risky way to invest. Since stocks generate the best return over time, your money grows the fastest vs. inflation. If stocks grow at, say, 10%, even after 3% inflation you are ahead 7%. If you put your money in CDs at 2%, you are actually losing 1% a year (2% return less 3% inflation.) For savings that won’t be needed for many years, is the volatility of stocks the greater risk or is the greater risk the possibility that other investment types won’t keep you ahead of inflation?

Not For Everyone

The "buy and hold stocks for the long run" mantra is not the best approach for everyone. Stocks are appropriate for money you don't need in the next 15 years. For someone like me in their early 40s, I won't need much, if any, of my savings in the next 15 years, so I have it all in stocks, less an emergency cash reserve. For my mom who's in her early 60s, quite a bit of her savings will probably be needed in the next 15 years. She would want to invest a much smaller portion in stocks.

Stock Returns Make Sense

The fact that stocks win over time makes a lot of sense if you think about it. Private enterprise is the greatest wealth creator ever devised by man. Owning stocks means owning your piece of that juggernaut and sharing in the profits it generates.

Next topic: How can 80% of people be wrong? How best to invest in stocks? There's the smart way and then there's how 80% of people do it.

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