Fix your portfolio

Now that the wreck of 2008 is over, here's how to put the pieces back together - no matter what kind of investor you are.

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Scenario 1: You did it right and still you lost
Scenario 1: You did it right and still you lost
Target allocation: A mix of 60% stocks and 40% bonds is the classic balanced portfolio for a middle-of-the-road investor. It should deliver inflation-beating returns.
Problem: A middle-of-the-road, play-by-the-rules type, you chose a prudent mix of stocks, bonds and other assets. But you got creamed anyway.

Losses last year: 25% to 35%

Goal now: To earn inflation-beating returns over the next 20 years so you can still retire comfortably - while minimizing gut-wrenching losses along the way.

How to get there: Because your original asset allocation was solid, all you need to do is rebalance. If your target allocation is 60% stocks and 40% bonds, for example, you're probably more like fifty-fifty now - so sell bonds and buy stocks until you get back to those target percentages. Rebalancing forces you to buy low and sell high, which over time can translate into bigger gains. A study by T. Rowe Price compared the returns between 2000 and 2007 of a 60% stock/40% fixed-income portfolio that was rebalanced annually with one that was not. The rebalanced portfolio suffered fewer losses in the 2000-02 bear market - and by 2007 it had grown 70% larger.

In tax-sheltered accounts like your 401(k) or IRA, rebalance immediately. In taxable accounts, you can save yourself from an IRS bite on the sale of any appreciated assets (like bonds) by simply funneling your new investment money into stocks until you're back to your target percentages.

NEXT: Scenario 2: You diversified into whatever was hot
Last updated January 14 2009: 6:15 AM ET
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