Sitting on $100,000

NEW YORK (Money) -- Question: Is now the time to invest new money in mutual funds? I've been sitting on $100,000 for over a year because the market has been climbing to historic highs. I have always been told to buy low and sell high, so do you think I should wait for the correction before I invest this money. Or should I just invest it now? - Mike B., Memphis, Tenn.

Answer: You're a great example of the mind games investors inflict on themselves. Anxious about rising stock prices a year ago, you decided to hold off investing in mutual funds.

I'm sure that decision made sense to you at the time. After all, you probably figured you were protecting yourself from a correction and also setting yourself up for an opportunity to buy stocks at cheaper prices.

You know now that far from dropping, stock prices kept rising. In fact, had you invested your hundred grand in an index mutual fund tied to the Standard & Poor's 500 index, you would have earned about 15 percent by now, roughly three times as much as you probably got in a cash account.

Which means you're really in a bind now. You're upset that you missed the market's move. But investing now seems even more dicey.

What, oh what, is an investor to do?

Well, the first thing you should do is stop agonizing. The notion that you can predict the ideal times to get in and out of the stock market is absurd.

Granted, stock prices do sometimes get so gaseous that they're more likely to stall, or even fall, rather than continue climbing. But it's hardly a no-brainer to say when they've hit that level. And even if stocks do look pricey (and I'm not saying that's the case now), it doesn't mean a fall is imminent.

Stocks can go from overvalued to even more overvalued and stay in that territory a long time.

So how, then, do you protect yourself from the risk of getting whacked with a big 'ol market downturn as soon as you invest your hard-earned cash?

Two ways.

The first is to practice asset allocation, which is a fancy way of saying spread your money among different types of assets. The most important decision is how much you put in stocks, bonds and cash. But you can divvy it up even more finely within those categories, putting some in large-cap stocks, some in small-caps, some in foreign, for example.

In the case of bonds, you may want to hold some in government securities, some in corporates and further diversify by maturity, or the length of time before the issuer repays the bond's face value.

Now, this doesn't offer absolute protection. The stock portion of your holdings will still drop if the market does. But the less you put in stocks and the more you put in short-term bonds and cash, the more stable your portfolio's value will be.

I should caution you, though, that while simply loading up on bonds and cash will protect you from fallout if the market takes a dive, that strategy would also reduce your potential for long-term gains. Ideally, therefore, the mix of stocks and bonds you choose should reflect both your time horizon (how long until you'll need the money you're investing) and your risk tolerance (how you feel when your portfolio's value dips, even if temporarily).

If you're investing money you'll need in a couple of years (say, for a house down payment or to pay college tuition), then virtually all of it should be in cash and maybe a bit in short-term bonds. You can't afford to invest in stocks only to find yourself in the midst of a 20-percent correction when you're ready to go to the closing table or the tuition office.

If you're investing for a far off goal like retirement, however, then you shouldn't be concerned about short-term fluctuations. Your eye should be on the eventual size of your nest egg. And by devoting most of your money to stocks during your career, you'll have a better shot at accumulating enough moolah to allow you to retire in comfort. For guidelines on how to divvy up your portfolio among stocks and bonds based on your risk tolerance and time horizon, you can go to our Asset Allocator "Fix Your Mix" tool.

If you'd like to get an idea of how much different asset mixes are likely to perform, check out the Asset Allocator at T. Rowe Price's site. (It's free, but you'll have to register.) And while you're at it, you should check out the Asset Allocation lesson at MONEY 101.

Which brings us to the second way you can protect yourself from the ups and downs of the stock market. And that is to invest your money as you get it rather than hoarding it and trying to figure out the best time to put it into the market.

This technique, by the way, is what makes 401(k)s such a great way to invest for retirement (aside from the tax benefits).

I'm not saying that this sort of regimen will bring the highest return any more than asset allocation will. But investing on a regular basis will assure that you don't put all of your money in at a bad time. Having a consistent system will also save you from having to figure out whether you're investing at the ideal time.

It will also take some of the anxiety out of the process since you'll be investing smaller sums regularly (and at a variety of prices) as opposed to making momentous decisions with big sums every once in a while, which can put a lot of pressure on you and lead you to second guess yourself.

So stop this guessing game about when to start investing your money in mutual funds and instead build yourself a portfolio that makes sense for your situation. You'll improve your financial prospects and lower your angst level too.