Investing when 'paralyzed with fear'

NEW YORK (Money) -- I've been investing my retirement accounts in a combination of stock and bond index funds, REITs and a few other investments for 10 years. But after going through the crash and watching the hard-earned equity in my home vanish, I've been investing more conservatively, putting much more in cash than I usually do.

I want to get back to my original investment mix, but I'm paralyzed with fear. I've still got 15 to 20 years before I retire, so I know this cash is really an albatross around my neck. But I don't know what to do. How do I overcome this fear? -- Cindy, California

If it's any consolation, you're not the only one with the jitters. Given the sturm und drang about raising the debt ceiling, worries about anemic job growth and questions about the strength of the European banking system, most investors are on edge.

And it's not as if this anxiety has been building just the past couple of weeks. Many of these issues have been simmering for months, which no doubt is why Morningstar figures show that investors yanked a net $18 billion out of U.S. stock funds in June, the largest outflow since the height of the credit crisis back in October 2008.

But while feeling skittish is understandable, you don't want to let your short-term emotional reactions dictate your long-term investing strategy. Granted, the issues I've mentioned above are serious.

But you're talking about retirement money. This isn't dough you're investing for the next two weeks or two months or even two years. It's money you're investing for two decades, and actually longer since you're not going to cash out the day you retire.

So you want to set an investing strategy that will work for the long-term. Otherwise, you run the risk of becoming one of those people who flee to cash or other perceived safe havens when everyone is focusing on the catastrophe du jour -- and then do the opposite, shifting their money from and into stocks when everyone's euphoric about the economy and the markets.

"In-N-Out" may be a great name for a burger chain. But it's not a good recipe for building a nest egg for retirement. All of which is to say that you need to get back to what you were doing before: investing a diversified portfolio appropriate for your age and risk tolerance and -- aside from occasional rebalancing -- sticking with it.

In light of your recent experience, it wouldn't hurt for you to re-consider just what your long-term investment strategy should be. You don't want to wimp out and limit your growth potential.

We paid cash for our million-dollar home

On the other hand, maybe the reason you fled to cash was that your original stocks-bonds ratio was actually a little too racy for you. So I suggest you go to Morningstar's Asset Allocator tool and adjust the sliders to see how different combos of stocks and bonds might perform over the next 10 to 20 years.

Once you've got a mix you think you'll feel comfortable with in both up and down markets, plug that portfolio, along with the value of your investments and the amount you're saving annually, into T. Rowe Price's Retirement Income Calculator.

This will give you a sense of whether you're on track to a secure retirement based on what you're saving and how you're investing.

Once you know where you want your retirement investment portfolio to be, the next question is how do you get there?

I say you should move to your target stocks-bonds mix as quickly as possible. I know that puts me at odds with people who would recommend you take a dollar-cost-averaging approach and move in gradually. But as I've noted before, that strategy doesn't really make sense financially.

After all, if your retirement accounts are currently invested, say, 30% in stocks and 70% in bonds and you know they should be the other way around, why would you want to delay getting to the right tradeoff of risk vs. return?

In effect, you would be undermining the very strategy you've just concluded is best for you. (Okay, in the case of assets in taxable accounts there may be tax-related reasons not to shift all your assets at once, but you would still want to get to the right mix sooner rather than later.)

But I recognize that some people just can't do that, whether due to fear or other reasons. And for people in that position -- and it appears you're one of them -- making the move a bit at a time is better than not doing it at all.

If you're going to take the gradual approach, though, I recommend that you at least set a schedule. You could move a pre-set percentage of your portfolio or a certain dollar amount from cash (or whatever asset class you're overweight) to stocks (or wherever else you're light) so you get to your target mix over the course of six months to a year.

This way, you'll at least be going about it systematically rather just winging it, and you'll be less apt to succumb to another case of the jitters and back out.

What you don't want to do, though, is dither or obsess about his move. Nor do you want to play the game so popular these days of trying to figure out what will hold up (Gold? German bonds? The Chinese yuan?) should the debt negotiations falter and the U.S. technically default.

That's a guessing game -- and not one worth engaging in when you're investing money you won't need for more than two decades down the road.

Besides, the whole point of owning a diversified mix of investments is that you can't consistently pick short-term winners and losers. If that were possible, you wouldn't need to diversify in the first place.

So figure out what your mix should be for the long-term and get to that blend as soon as you can. And then try to stay calm so you don't get spooked again by the next big crisis, whatever it may be.