Make fear and greed work for you

3. Devise a strategy you can live with

To avoid the risks that investing at the extremes entails, you need a plan you'll be able to stick to no matter what the market does. The strategy should take into account your age and circumstances and offer some growth (to feed the greed urge) and protection against downturns (to calm any fears).

"Going forward, volatility is probably going to be worse than what we were accustomed to before this recession, so you need an approach that will allow you to cope without panicking," says Harold Evensky, a Coral Gables, Fla., financial planner.

Start with the basics: asset allocation. As a rough rule, you should have 70% to 80% of your retirement savings in U.S. and foreign stock funds when you're in your forties, with the rest in bonds or stable-value funds. Ratchet down the stock portion by 10 percentage points in your fifties, and again in your sixties.

The chances are good that you will make almost as much money as you would with a more stock-laden portfolio, T. Rowe says. And you'll do so with far fewer stomach-clenching twists and turns; the standard deviation for a 60/40 stock/bond mix, for example, is nearly half that of stocks.

Then settle on a strategy to help you pick specific investments within these asset classes. Potentially profitable courses: focusing on dividend-paying stocks that can deliver above-average total returns as well as sectors like energy and tech where profits seem poised to grow at the first signs of economic recovery.

4. Play at the margins

Still, you're only human. If it seems as if everyone around you is snapping up shares of the market's latest darling, it's hard to sit idly by with your staid portfolio, reminding yourself that you'll be better off in the long run.

So don't. A little speculation can be healthy, experts say, as long as you keep it in check, using no more than 5% of your total portfolio to play your hunches. "If you feel in control of just a small portion of your investments, you'll be happier even if you lose money," says UCLA finance professor and risk specialist Subra Subrahmanyam.

Consider how this approach can protect your portfolio if the market moves against you. Say you usually keep 60% of your savings in big U.S. stocks, with the rest split between bonds and foreign stocks. But after Lehman Brothers failed, you decided to take a flier on Citigroup (C, Fortune 500), which looked like a bargain after toppling from $48 to $20 a share.

Fast-forward to today, when Citi sells for about $3. If you hadn't bought the stock, your portfolio would be off 19%. If you'd limited your bet to 5% of your portfolio, you'd have lost 22%. But if your Citi stake made up 25% of your holdings, you'd be down 32%. Ouch.

5. Emphasize input, not output

The desire to make up the steep losses of 2008 and early 2009 - and to avoid declines going forward - amplifies the normal tug that many people feel between fear and greed. But the surest way to get back to even and start making money again is not to choose the "right" investment, it's to simply keep on saving as much as you can.

Just take a look at your latest 401(k) statement. Really. Between January 2008 and May 2009, the average 401(k) balance for workers ages 45 to 54 who'd been with the same employer for five to nine years dropped 9%. During the same period, the S&P 500 plummeted 38%. Consistent contributions and dollar-cost averaging into a down market allowed savers to capitalize on the spring rally. Matching contributions from employers didn't hurt either.

More evidence: Vanguard recently ran the numbers for someone making $100,000 a year, contributing 6% to his 401(k), and investing 70% in stocks and 30% in bonds. After 25 years, his balance would be $329,000, assuming he earned average returns. If he'd saved only 4% of pay but tried to make up for it with a more aggressive blend of 80% stocks and 20% bonds, he'd end up with only $223,000.

"A slightly higher savings rate is much more effective at building your wealth than a substantially riskier portfolio," says Don Bennyhoff, a senior investment analyst with the Vanguard Investment Strategy Group.

The lesson is clear: If you're not already maxing out contributions to your employer-sponsored retirement account, get with the program now. If you are but can afford to save even more, start doing so immediately, either in a Roth IRA (if you're eligible) or a taxable account (if you're not). Forget the siren calls of fear and greed; saving more is the closest thing to a sure investment bet you'll get.  

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