Aristotle once wrote that there are only seven stories to be told, and all drama is a variation on one of these seven stories.

While not as profound, there's a personal finance equivalent to this truism. There are seven stories to write on matters for individual investors, and all personal finance stories are variations on the same seven stories. No matter how we dress up different stories, every personal finance column can be reduced to one of these basic seven tenets. Today's Financial Education column will explain the essence of each of these seven stories.

Story No. 1: Diversify, Diversify, Diversify, or Mark Twain Was Wrong

We have all heard the Mark Twain line from Pudd'nhead Wilson: "Put all your eggs in one basket and watch that basket." Well, Mark Twain was his era's Willie Nelson -- a celebrity who frequently had difficulty managing his assets. A better investing truism comes from Shakespeare's Merchant of Venice: "My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year; therefore, my merchandise makes me not sad."

Of the seven personal finance stories, this is the simplest, the most important and the most often misconstrued. Proper asset allocation is the key to long-term investing. Ibbotson Associates, an authoritative source on asset allocation, found that about 90% of the variability of returns over time is due to asset allocation.

Let's briefly explain what diversification is, and what it isn't. Diversifying is spreading your assets among several classes that don't always move in tandem -- large stocks, small stocks, bonds, international and real estate, for instance. Diversifying enables investors to reduce the risk of their portfolio without losing on the returns side of the long haul.

Diversification is not spreading your money around five, six or 15 mutual funds, if they are overwhelmingly large-cap growth, large-cap value. Those two classes have a 96% correlation, which means they move in tandem almost all of the time. Anyone who owned a Janus fund, an S&P 500 index fund, Fidelity's Magellan fund and a few other large-cap funds that move up, and down, in sync doesn't need to be informed of the perils of having too much retirement money in one basket.

Want to know if you're diversified? A good place to start is Morningstar's Portfolio X-Ray .

We'll leave this section with the three fundamental long-term truths of diversification:

  • 1. Stocks beat bonds, bonds beat cash.

  • 2. Small stocks beat large stocks.

  • 3. Value beats growth.

    Story No. 2: Know Thyself -- and Thy Portfolio

    "Invest Safely and Make 20% or More" -- a personal finance magazine headline in September 1996.

    A lot of people lost touch with reality when it came to how much risk they could accept in the go-go 1990s. The newspapers have been littered the past three years with terrible stories about retirees who lost their paper fortunes because they took on too much risk.

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