NEW YORK (CNN/Money) -
Ahh, 1999. A great year for your portfolio. But thanks to the bear market, all of those lovely gains have been wiped out. Gone.
In fact, it's as if 1999 never happened. The Dow Jones industrial average is trading at the same level it was in early 1999. Investors learned the hard way that what Wall Street giveth, Wall Street can taketh away.
"It's been a wild ride, but we're back where we started four years ago," said Mark Groesbeck, a certified financial planner in Houston.
Still, we have learned some lessons along the way. For example, we know how important it is to diversify a portfolio. We realize that technology -- or anything that's on a roll -- shouldn't be the centerpiece of a portfolio. Bonds are no longer something we buy only when we're ready to retire. And, we understand that in a rotten market it's important to be creative and open to new strategies.
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Four lessons from the bear market:
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| • | 1. Asset allocation works.
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| • | 2. Don't chase what's hot.
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| • | 3. Don't overlook bonds - they may save you.
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| • | 4. A bad market requires creativity.
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"Hopefully we won't lose sight of these lessons the next time there's a bull market," said Rick Applegate, a certified financial planner in Pittsburgh.
Lesson No. 1: Asset allocation works. Asset allocation may have seemed like a boring concept back in 1999. But everybody who loaded up on growth stocks back in the "good old days" probably wish they had used the strategy.
By spreading your bets between different types of stocks and bonds you won't earn as much during great markets, but you won't fall as hard during tough times. Small caps were underperformers for years but have buoyed many portfolios in this downturn. You want to have some exposure to different types of stocks because you don't know where the next upswing will be. (For help building an asset allocation plan, click here. Or, try CNN/Money's asset allocation tool by clicking here.)
Lesson No. 2: Don't chase what's hot. Technology once seemed the path to riches. There was dot-this and dot-that, and Qualcomm was up 2,600 percent. Applegate said he was amazed at how many people would take loans out on their homes, or empty a child's college savings fund, to put some money in a hot stock. More often than not, it was in technology.
"They were asking, 'What about Qualcomm?' " Applegate said. "They didn't see any risk."
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Coping with the bear market:
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Now we know better. Two years after the Nasdaq peaked on March 10, 2000, at least 40 tech funds have closed or merged. (Click here for more on the tech fund implosion.) Indeed, some investing pros question whether you even need a tech fund in your lineup. Many recommend a diversified growth fund. (For more on alternatives to tech funds, click here.)
Similarly, we're not going to throw our money at gold funds just because they're up 48 percent this year. Nobody has any idea whether or not that gold rush will continue -- or for how long.
There are risks to stock investing -- and that you better be prepared for a longer wait if you put money in the market. (If you do need to invest for a shorter time period, say, three to five years, click here for some great funds.)
Lesson No. 3: Don't overlook bonds -- they may save you. Nobody cared about bonds during the bull market, but they were one of the only ways to make money in the past two years. For example, intermediate-term bond funds, the bread-and-butter funds most people start with in fixed income, have a three-year annualized return of 5.5 percent, according to Morningstar. Tech funds, by contrast, have an annualized loss of 13.4 percent in that time. Large growth funds aren't much better, with a loss of 8.5 percent.
With an endless stream of earnings warnings, trouble in the Middle East and an uncertain economy, you might be more open to a owning a bond fund in your portfolio. They may not go up as much as a high-voltage stock fund but they sure won't fall as hard during their bad years. Take Harbor Bond Fund. In its worst year, 1999, it lost just 0.3 percent.
A lot of people have a hard time figuring out how bonds work -- let alone what bond fund is right for them. It isn't as important what type of investor you are as it is how much of your portfolio is in fixed income. (Click here for five great bond funds.)
Lesson No. 4: A bad market requires creativity.
Forget about finding the next Microsoft. The bear market taught us that tough times require you to be a smart strategist. Dollar-cost averaging, for example, will lower your risk. That's where you commit to investing a small amount of money every month. And in an era of Enron-induced suspicion, nothing might seem safer than dividend-paying stocks, where companies distribute profits to investors.
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Convertible securities, where a bond converts to a stock or vice versa, are another nice hedge. You have the stock protection on the upside and a bond with a coupon on the downside.
Groesbeck likes to recommend Calamos funds, a well-known convertible bond shop. Among his favorites are Calamos Convertible. It has a three-year annualized return of 9.5 percent, and a healthy 12.5 percent over five years, according to Morningstar. The fund invests in high-quality bonds of companies such as Boeing, GM and Washington Mutual.
(For more about strategies for a can't-win market, click here.)
"We're focusing on preservation of capital," Groesbeck said. "I'm telling them to be happy with modest returns."
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