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How to Beat a Bust

Second, there's diversification within an asset class. Beyond getting out of one stock, you want to spread yourself a bit across different kinds of stocks -- big American companies, small and medium-size companies, and today, with all the worries about the federal deficit, the trade deficit and the dollar, some foreign stocks as well.

Third, there's asset class diversification. That refers to other types of investments such as bonds, real estate and the like. This sort of diversification helps under different economic conditions. Bonds, for example, rise in price when interest rates fall. Thus, while a slowing economy can be bad news for stocks, it may not be for bonds. That's because when the economy slows, the Federal Reserve tends to cut interest rates. If rates fall, prices of bonds go up, helping to offset stocks' dip.

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Rebalancing -- One of the hardest of all investment decisions is deciding to sell an asset that is doing well. Setting a rebalancing strategy and sticking to it will help.

The idea here is to decide in advance on the allocation of investment assets that makes the most sense for you and with which you are most comfortable. For example, you may figure you need the long-term growth potential of stocks but are a little edgy about their ups and downs. So you might decide on a portfolio of 70 percent stocks, 20 percent bonds and 10 percent cash or something else such as real estate.

You spread you money accordingly, and then every so often, and at least annually, experts say, you add everything up and see if your alignment has gotten out of whack. In a time like the late 1990s, you would likely have found that stocks had jumped and bonds declined, so you would find yourself with 85 percent stocks and 5 percent bonds.

To rebalance, you sell a portion of your stocks and put the proceeds into bonds until the desired proportions are restored. The rebalancing forces you to sell high and buy low -- the opposite of what many investors ruefully say they do.

In the 1990s, you might have missed out on some of the stock run-up, but you would have taken winnings off the table and actually put them on a horse -- bonds -- that was about to make a great run.

• Dollar-cost averaging -- Putting money into the market in the first place is another nerve-racking decision many have trouble with. One way to deal with it is to invest regular amounts at regular intervals. That way you buy fewer shares when prices are up, and more when prices are down. You don't hit as many home runs this way, but you also are less likely to strike out. And it keeps you buying -- but at a measured pace -- when things are bad.

This is, of course, the way 401(k) plans work, and it's one of the reasons k-plan participants didn't fare as badly as some other investors during the plunge. They stuck with their investing programs and bought cheaper shares in 2001 and 2002, in time to see them ride up with the market in 2003 and last year.

So what's the best way to implement these strategies?

For beginners, mutual funds provide instant diversification. Of course, funds are generally restricted to certain kinds of stocks, but you can divide your money among several to provide yourself with a broad range. Index funds allow you to pick market segments while paying minimal fees.

Similarly, bond mutual funds give you diversification that you can't get with individual bonds unless you have a lot of money to invest.

Later you may wish to try buying individual stocks and bonds. Today, dividends get very good tax treatment, so established, profitable companies that pay dividends are a relatively low-risk place to start. And, with interest rates very low and likely to go up, a "laddered" collection of bonds -- chosen so you'll have some maturing every so often -- will allow you to reinvest to capture rising rates as time passes.

Rebalancing is usually very easy with a 401(k) or individual retirement account, but rebalancing in a taxable account means you'll have to, well, pay taxes.

But rates are favorable as long as you hold the assets for at least a year, and, as the saying goes, better to make money and pay taxes than not to.

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