'Should I invest my $10,000 windfall in stocks?'

@Money June 1, 2012: 9:34 AM ET

(Money magazine) -- I'm 29 and just came into an extra $10,000. My overall finances are in good shape, so I want to put some of this money into the stock market. How do you recommend I do that? -- John H., Encino, Calif.

Wait a minute. At a time when surveys show investors have been retreating from equities and Facebook's IPO debacle has made them even more wary of the stock market, you're telling me you want to get into stocks?

Can that possibly be a wise decision?

The answer, ironically enough, is yes. As long as you're investing for the long term and have the stomach to ride out the market's periodic gut-wrenching setbacks, I think you're smart to put some of your money into stocks even if your fellow investors are shunning them.

In fact, the more disenchanted people get with the market, the higher the returns stocks are likely to deliver in the future. Or, as Ibbotson Associates founder and stock-market guru, Roger Ibbotson, once explained to me in an interview: "It's when you're most afraid of stocks that they have the most potential."

The reason is simple: When you buy a stock, you are essentially buying a share of a company's future earnings. The more fearful people are about the market's prospects, the less you have to pay for a piece of those earnings -- and the greater your potential profit when you eventually sell.

Stock gains are never guaranteed, of course. But novice and veteran investors alike can increase their chances of reaping stocks' superior long-term returns by following these four simple rules:

1. Tune out the hype. It's always a good idea to stay abreast of what's going on in the markets and the economy. But it's a mistake to let the financial news drive your investing decisions.

By the time you hear about the latest corporate earnings numbers or most recent move to clean up the European debt crisis, any useful information has already been factored into market prices, leaving you no chance to gain an edge.

So don't waste your time trying to glean investing tidbits from the tsunami of blather on cable TV investing shows and such.

Instead, check out resources that can actually help you create a coherent long-term investing strategy, such as Morningstar's Investing Classroom and our MONEY 101 lessons on investing in stocks, bonds, mutual funds and asset allocation.

2. Forget stocks, buy the market. Wall Street creates the impression that the road to wealth lies in being a great stock picker. The reality, though, is that after paying trading costs and other fees, the overwhelming majority of investors, including pros, trail the market averages. So don't even try to beat the market -- buy it instead.

Specifically, invest in a total stock market index fund, which gives you the entire U.S. stock market -- large companies, small, popular fast-growing stocks and ignored undervalued shares, basically stocks of every sector and industry in the economy -- in a single fund.

This eliminates the guesswork of trying to figure out which companies and industries are likely to outperform in the years ahead. You'll own them all. You can find total stock market index funds on our MONEY 70 list of recommended funds.

3. Get some bonds, too. Even a well-diversified all-stock portfolio can take some nasty dives, witness the 51% decline in Vanguard's total stock market portfolio (VTSMX) from the end of October 2007 to the end of February 2009.

To give yourself a little protection from stock market spills, you'll also want to invest at least a portion of your ten grand stash to a Vanguard total bond market index fund (VBMFX).

For a sense of how much you might want to devote to bonds, check out our asset allocator tool. Once you've set a stocks-bonds mix, don't fiddle with it. Just rebalance every year or so to bring your holdings back to their original proportions and keep the risk level in your portfolio constant.

4. Be a cheapskate. Most investors focus almost exclusively on returns, even though they have no control over them. You're better off paying more attention to an aspect of investing you can control: the investment expenses you pay.

Every dollar you shell out in costs is one dollar less you pocket in net returns.

Over the long term, holding down investment fees can make a big difference. For example, paying 0.5% in yearly costs versus 1.5% would leave you with an extra $6,000 or so after 20 years on just one $10,000 investment, assuming a 7% annual return before expenses.

Bottom line: Putting a portion of your $10,000 windfall into the stock market -- despite your fellow investors' misgivings -- is a good idea. And you can make it even better by staying on course, creating a diversified portfolio that includes stocks and bonds and keeping your expenses down.


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