NEW YORK (CNN/Money) - My husband and I are retiring in six months. He'll be 62 and I'll be 58. We've lost about $140,000 in his 401(K) over past 2 years, but he insists on keeping all of it in a Standard & Poor's 500 index fund, figuring if he moves or diversifies it, he'll lose out. I say diversify now to minimize any more loss, then just watch the market. What do you suggest?

-- Lynn Chreste, Frederick, Maryland

I admire the fact that your husband isn't ready to abandon his investment strategy just because the market's been down the past two years. That said, however, I think I'll have to side with you and try to make the case for a bit more diversity. I do this because I believe a well diversified portfolio is pretty much the best hedge we have when dealing with the inherent uncertainty in the financial markets.

So, what kind of diversification do I recommend? Let's start with stocks. An S&P 500 fund already has you well on the road to decent diversification. After all, you've got 500 stocks plus a mix of industries and different sectors that reflects the diversity of the U.S. economy.

One thing you are lacking is small-company exposure. Typically, large- vs. small-cap performance runs in cycles, with the big boys getting the upper hand for a few years (or more than a few years as they did in the mid- through late 1990s) and then the little guys taking the lead. Forecasting which will lead the way and for how long is, in my opinion, a waste of time. But by owning both, your portfolio benefits no matter which is leading the parade.

You don't have to go overboard when stocking up on small fry. Basically, small-caps should represent 10 percent or so of your stock holdings, about the same percentage they represent of the market value of the U.S. market. You can get that exposure by buying a small-cap index fund or one or more broadly diversified, actively managed small-cap funds. To screen for some candidates, check out our Fund Screener. Or you can choose from the small-cap offerings on the Money 100, a collection of solid funds selected by the editors of MONEY Magazine.

If you want to hedge your bets a bit more, you can also consider adding an international fund. Even in today's global economy, not all stock markets around the world move in synch. So by adding a fund that invests "Over There," you increase the odds that part of your portfolio will continue to chug along even when the U.S. market is struggling. For details on what kind of international fund you should consider and how much of your portfolio you should invest in it, click here.

Finally, have you and your husband considered bonds or bond funds? True, stocks have generated the best returns over the long run. And I believe that people who are just entering retirement still generally need to keep the bulk of their assets in equities. Given current life expectancies, most of us will probably be spending 20 to 30, maybe even 40, years in retirement. To prevent the purchasing power of a portfolio from being whittled away by inflation, you need a good slug of stocks.

And, as the past two years have shown, stocks do go through periodic downdrafts. At times like these, having a position in bonds can add a bit of stability to your portfolio. I generally recommend short- to intermediate-term bonds or bond funds so that your portfolio doesn't sustain too much damage if interest rates head north again.

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As to the issue of how much of your portfolio should be in bonds, the answer depends on a variety of factors, including how comfortable you are seeing your portfolio's value take a dive during market downturns, what size annual withdrawals you plan to make from your portfolio during retirement and how much wiggle room you have to trim your withdrawals during periods when returns are low.

I'd say a bond allocation of 25 to 40 percent of your total portfolio is a good starting point for you to consider. But before making a final decision, I recommend you try out the T. Rowe Price Retirement Income Calculator, which gives you the odds that you'll be able to sustain various levels of monthly withdrawals from your portfolio with different allocations of stocks and bonds.

Oh, one more thing. Once you get your asset mix to where you both feel comfortable with it, don't muck things up by changing it around each time the market hiccups. Just re-balance occasionally -- say, once a year -- to bring the proportions back to their target allocations. But given your husband's resistance to change, I suspect that over-managing your portfolio won't be a problem.

Walter Updegrave is the author of Investing for the Financially Challenged and can be seen regularly Monday mornings at 8:40 am on CNNfn.