Hard Times Mean Hard Thinking

Once again, stocks plunged just when investors were starting to feel fat and happy. Once again, a recession rained down. Two things are different this time (every downturn is different in its own unhappy way). The credit squeeze makes it hard to borrow your way out of trouble, and a "new" investment—commodities—seems fit for retirement plans. Some lessons to heed:

There ' s no substitute for cash. Money you're going to need in the next couple of years—for current bills, meeting a payroll, a house closing, whatever—should sit in places where cash is safe: an insured bank account or a plain-vanilla money-market fund at a large institution that will protect the fund from loss. It doesn't matter that you're earning less than the inflation rate. This is not an investment, it's your wallet. Savers who reached for higher interest rates, in "cash-plus" funds or ultra-short bond funds, are losing money, sometimes a lot.

Diversification works. Sneerers say that diversification is overrated because all the world's stock markets have dropped together. Ignore them. Just three simple examples show why:

An undiversified investment in Standard & Poor's average of 500 leading U.S. companies earned 1.66 percent from 2000 through 2007. Money split three ways—65 percent in the S&P, 25 percent in leading international stocks, 10 percent in emerging markets—gained 4.33 percent. Reducing the S&P investment and adding 20 percent in smaller stocks raised the take to 6.34 percent—all without raising a finger. (For these data, thanks to Morningstar's Ibbotson Associates.)

Commodities can be your friend. I first wrote about commodities in 2005, and with a trembling hand. I thought they might be a bit, well, far out for the average investor. Now I think they're a good addition to an investment plan.

On fundamentals, their story lies in the voracious demand for oil, food and metals in fast-developing Asia, Africa and Latin America. Their strategic advantage lies in their "low correlation"—meaning that, when stocks zig, commodities often zag. Craig Israelsen, a professor at Brigham Young University, found that adding commodities to a diversified portfolio reduces volatility and lowers your chance of losing money, long term. Owning them makes sense, even if today's high, bubbly prices break.