The good, bad and ugly

In Lesson 4

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Top things to know The good, bad and ugly Stock market movers Bonding with bonds Mutual fund fundamentals The hidden peril of inflation

Money 101 Lessons

Setting priorities Making a budget Basics of banking and saving Basics of investing Investing in stocks Investing in mutual funds Investing in bonds Buying a home Controlling debt Employee stock options Saving for college Kids and money Planning for retirement Asset allocation Hiring financial help Health insurance Buying a car Taxes Home insurance Life insurance Estate planning Auto insurance 401(k)s

Unless you slept through the 1990s, you probably know that the decade witnessed the aftermath of the Cold War, the sexual adventures of Bill Clinton, and the biggest bull market in U.S. history. During the decade the Dow more than quadrupled.

While stocks, as represented by the S&P 500, have not always performed so extraordinarily - compounding at a dazzling 15.3 percent annual rate for that time period - they have usually been the best performing asset class over time.

Since 1926, stocks have returned an annual average of 10.4 percent through 2006. Over the same period, government bonds returned 5.9 percent, and "cash," the term used to describe Treasury bills and other short-term investments, has returned just 3.7 percent. (This according to the folks at Ibbotson Associates in Chicago.) In other words, if you're investing for the long-term, stocks are the place to be.

But if you're looking to invest money you may need in a year or two, the stock market can be downright dangerous. Look no further than the Dow's 554-point drop - a 7.2 percent loss - on Oct. 27, 1997, and the 508-point drop on Oct. 19, 1987 - a harrowing 22.6 percent loss - to see what a difference a day can make.

Then there are those bloody bear markets, like 1973-74, when the Dow fell 45 percent, and the one that began in March 2000 - when the Nasdaq Composite fell more than 75 percent over about three years - to remind you that the market may not be the best place to keep your down payment for a house.

To cite a severe example, if you had bought the stocks in the Dow Jones industrial average at their peak in early 1966, you wouldn't have made any significant profit until mid-1983 - more than 17 years later. Even that was better than if you'd bought in the pre-crash peak of 1929. After that, it took until 1954 for the market to regain all it lost in the Depression. As for the market woes of the early 2000s, it would take more than five years using an historical average rate of return, for the Dow to return to its glory-day levels from its October 2002 low.

Bonds, of course, are another story. While they won't give your portfolio the kind of kick that stocks will, nor are they likely to give it the same kind of thrashing. In 1994, the worst single year for bonds in recent history, intermediate-term government bonds (that is, Treasury securities with maturities of 7 to 10 years) fell just 1.8 percent. In the good year that immediately followed, they bounced back an impressive 14.4 percent. From 2000 through 2002, bonds outperformed stocks every year - an historic "three-peat" that hadn't been seen in the modern investment era that began in 1929.

In the sections to come, you'll find a brief overview of stocks, bonds and mutual funds and a first look at the deleterious effects of inflation. We have more to say about all of them in later Money 101 lessons.

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