In an attempt to preserve capital, some investors see a bear market as a reason to cash out. This, however, is typically a mistake if you have a long-term strategy for your investments. Other investors see the bear market as an opportunity to buy. In a bear market, the money already invested should be considered long-term money; it’s too late to sell in a down market. To avoid the compulsion to sell, you should not watch investment programs and you should not open your brokerage statement; there’s no point in it.

As many investment planners know, dark clouds have silver linings. Bad markets give investors an opportunity to revisit their investment strategies; an opportunity to take another look at their goals and assess the reasonableness of the assumptions they used in their initial investment planning. The diversification tactics you and your investment planner originally used may have lost their effectiveness.

Assets with low correlation to each other tend to have contrasting performance from year to year. This contrasting performance can be beneficial in a portfolio. Subsequently, a bear market gives you a great time to rebalance your portfolio. The term rebalancing implies a portfolio management protocol in which, at the end of a certain time period (for example, annually), the amount of money in each asset within a portfolio is either equalized or brought back to a predetermined percentage of the total portfolio. Rebalancing accomplishes the reduction of assets that performed best (or worst) and the reinvestment of those proceeds into other assets to bring the portfolio to its original balance. Rebalancing forces the investor to sell high and buy low periodically, a type of professional-level dollar-cost averaging.

What is the benefit of rebalancing your portfolio? To achieve a better return, or a reduction in volatility? With an asset-allocation portfolio that uses annual rebalancing, the goal may be both return and risk minimization. Moreover, by setting a pattern of rebalancing every year, an investor becomes accustomed to skimming profits off winners and depositing them into laggards. From this perspective, it’s possible to look at poorly performing assets in a more positive light, specifically as a signal to buy.

While it may be natural for the market to decline periodically, it is never easy for investors to stay calm. Here are a few strategies that may help weather the storm.

• Develop realistic return expectations. Although investors were thrilled when annual returns on the S&P 500 Index topped 35 percent, most investors should expect less than 10 percent returns from the stock market. History is the best indicator of what the market may do in the future.
  
  
• Diversify your portfolio. As one of the most venerable portfolio strategies, diversification can reduce overall volatility. It has long been understood that different asset classes react differently to changes in the economy and the financial markets. A portfolio composed solely of small-company stocks may not perform in the same way during a market downturn as a portfolio of large-capitalization stocks.
  
  
• Consider some actively managed funds over passive funds. In recent years, passively managed funds (index funds) have become popular. In downturns, these funds mirror the market and move where the market moves. Actively managed funds may be able to give more attractive, and more promising, investment opportunities and allow you to take defensive action, shielding against the downturn.
  
  
• Add to your portfolio by using dollar cost averaging. This strategy takes the guesswork from buying, because it is impossible to know where prices are headed.
  
  
• Stick with your investment strategy. If your portfolio is tailored to your goals, risk tolerance and time horizons, you probably won’t need to make drastic changes.
  
  
• Use your investment or financial planner. Your investment professional can assist you in analyzing opportunities objectively to avoid making decisions solely on the basis of performance.
  
  

A key step to a successful equity portfolio is to underscore history’s lesson about stock-market returns. Over the long term, equity investments provide strong returns and outperform inflation and many other assets. The best way to prepare for an uncertain future is to do two things: keep a long-term focus, and make sure that your portfolio is adequately diversified and fits your risk tolerance.

Jodye Deal is the owner of Gazelle Associates (www.gazelleassociates .com), an investment-planning firm based in Washington, DC. Send your questions on investing to investing@ gazelleassociates.com or call (202) 257-1350.