I’m 32 years old and my wife is 30. We weren’t able to start saving seriously until a year and a half ago, but at that time we started saving aggressively. Yet we’ve lost almost half ($10,000) of our portfolio in stocks and stock funds. I’ve been told that I can afford to take high risks because I have lots of time to catch up. But I’m very frustrated that the money I have lost, if compounded to retirement age, would be very significant. I’m starting to feel like I’m falling behind.

We are still saving, about $15,000 a year, and I am tempted to go after today's "bargain" prices and employ a buy-and-hold strategy. But I'm not ready to stomach another substantial loss. I'm tired of learning from my mistakes, and I'm now willing to be called an investing "sissy" and invest in bonds.

Can you give me a plan for becoming financially independent in 23 years? Is that a realistic plan?

Paul's Answer:

Your message raises several very interesting issues, which is why we picked it from among many questions we could tackle this week. Let's start with a simple one, the notion that you are tired of learning from your mistakes. At the age of 32, that is a very dangerous attitude for you to take, and I recommend you re-think it.

You should of course try to avoid mistakes, but whatever you do, they are inevitable. When you make mistakes, you should welcome them as lessons you can learn. At the same time, you want to keep your mistakes from derailing you and causing what some computer programs used to call a "fatal error." And by far the best way to limit the damage from any single mistake is to diversify.

At age 32 you say you are starting to feel like you are falling behind. But you still have plenty of years in which to earn money and invest it. If, as it sounds, you have about $10,000 now, I would guess that puts you slightly ahead of the average person your age. There are millions of households in the United States that do not have anywhere near $10,000 in investment assets.

Now, the nitty-gritty of your plight: You invested $20,000 in stocks and stock funds and you lost half of it. People tell you that's fine, that you can afford to take high risks because you've got lots of time to catch up. And you, meanwhile, are calculating in your head that if you lose half of your money every year until retirement, you'll be in bad shape! And you're right, you can't afford to keep losing money at that rate.

The $10,000 loss you took is very real. I don't know what funds or stocks you invested in, but I would bet they were heavy in technology, which to many people last year seemed like a no-brainer shortcut to wealth. The problem is that there are no shortcuts. Last year many inexperienced investors scoffed at us when we tried to tell them that super-aggressive stock investments were exposing them to the risk of 50 percent losses in the market. They thought we must be living on some other planet. But as you have learned the hard way, the concept of risk is not just theoretical. You can in fact lose, and that means that real money disappears.

Some people tell you it's OK to take big losses because you can make them up later. They are wrong. It's true that you should be willing and able to sustain some losses along the way. You should expect to make mistakes and welcome them as opportunities to learn. So the critical question is: What can you learn from this? I think you know the answers by now.

If you have $10,000 now and you can add $15,000 a year to your investments, you have very good prospects. If you did that and earned a 12 percent annualized return on your investments, you would have a portfolio worth about $113,000 after five years. After 10 years it would be worth about $295,000. And after 20 years it would be worth about $1.17 million. When you were 60 years old, you'd have about $3.1 million.

Notice that is the result of earning only 12 percent a year, not the 25 percent to 75 percent that a lot of young, inexperienced investors think they should be able to get from being very aggressive. You have seen what can happen to people who try that, and you didn't like what you saw!

Notice that is also the result of a lot of savings: $15,000 a year. It's easy to run those numbers on a calculator but harder in real life to do that, especially if you have a family to feed and clothe and educate. So while this is possible, I don't want you to think it will necessarily be a piece of cake.

So how could you get a compound return of 12 percent a year? First of all there is no guarantee of any of this, because it depends on what happens to the markets in the next couple of decades. But I think that's a realistic goal if you approach it right.

There are many ways you could invest in search of such a return, and here's a plan that will point you in the right direction. First of all, don't buy or hold individual stocks with more than 10 percent of your portfolio unless you have very specific and very reliable knowledge of some company or industry you want to invest in. The diversification and professional management you get from mutual funds is a much more reliable way to get where you want to go.

I recommend you create a core portfolio of no-load funds now and add any stocks only later. If you are determined to invest in individual stocks, do it later as you add more money. Right now, your job is to build a strong core and make sure you can stick with it.

It's not "sissy" to invest in bonds, which are a terrific way to tone down the volatility of a portfolio. It's very hard to get young people to see this, but you have already seen the light, and that's good. Because of that, I'll start by recommending you put 30 percent of your money in a balanced fund that contains both stocks and bonds. That might leave you with 15 percent of the portfolio in bonds, but they will be "disguised" in this fund so you won't have to admit to owning any bond fund if you don't want to. Consider Vanguard Balanced Index fund or Janus Balanced Fund.

Put another 20 percent of your portfolio in a large-cap growth fund. Vanguard 500 Index or Fidelity Spartan 500 Index are two excellent examples. If you prefer actively managed funds, consider Vanguard's U.S. Growth Index fund. For a combination of indexing and active management in a single fund, consider the TIAA-CREF Growth Equity Fund or its "socially-conscious" sibling if that appeals to you.

I'd put 35 percent of your portfolio in international stocks. To keep it simple you could choose the Vanguard Total International Stock Market Index or Fidelity's excellent Diversified International fund for starters. Later, as you add more money to your portfolio, you can add specialized international funds that focus on value stocks, small-cap stocks and even emerging markets stocks for a small part of the portfolio.

OK, with 30 percent in a balanced fund, 20 percent in large-cap U.S. growth and 35 percent in international, this leaves only 15 percent to cover U.S. value and small-cap stocks. I'd start by putting the 15 percent into a small-cap fund like Vanguard Small-Cap Index or Schwab Small-Cap Index. Next year, with your new money, add a U.S. value fund such as Vanguard Value Index or Selected American Shares. Both are excellent.

While you put your core investment portfolio back together this way, read up on basic investing. There are many articles on our Web site, and a good place to start would be "The Best Buy and Hold Strategy we Know." Also sign up for a free Internet subscription to our newsletter. Study our Model Portfolios. Read some good books on investing. If you do all this, you will be well on your way to what I predict will be a full and prosperous long-term recovery from the nasty lesson the market just taught you. Good luck!