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Panic-Proof Your Portfolio in 5 Minutes

Lurking in your mailbox, something scarier than the most ingenious Halloween decorations waits for you: your quarterly statements.

You already know they’re not going to be pretty. Unless you dumped everything into ultra-safe Treasury bonds before the choppy market turned into a hurricane, you're going to see some pretty serious losses in your portfolio. Take a look at just a few of the hardest-hit stocks in the past three months:

Stock

13-Week Return

AIG (NYSE: AIG  )

(85.3%)

Dynegy (NYSE: DYN  )

(63.5%)

McDermott International (NYSE: MDR  )

(63.7%)

Nortel Networks (NYSE: NT  )

(71.8%)

Petrohawk Energy (NYSE: HK  )

(65.5%)

Sirius XM Radio (Nasdaq: SIRI  )

(69.8%)

Mosaic (NYSE: MOS  )

(69.1%)

Source: Motley Fool CAPS, as of Oct. 3, 2008.

Granted, most people haven't lost quite that much in their overall portfolios. But even if you dodged all those bullets, the quarter's results are sure to come as a shock -- especially for those unaccustomed to seeing any losses at all. Since the end of June, the S&P 500 and the Nasdaq both fell more than 15%, while the Dow fell about 10%. International stocks took a much harder hit -- a broad world index was down 20%, while many emerging markets were down 25% to 30%.

As painful as the past quarter has been, the future seems even more uncertain. Whether the recent $700 billion rescue bill will work is anyone's guess. Over the weekend, Europe started making its own plans to shore up confidence in its own financial institutions. Here in the U.S., bad employment numbers have many worried about their jobs.

In the face of all that uncertainty, what should you do now?

Five cures for statement shock
When the world has you on the edge of panic, your best bet is to take a rational approach to the situation. By spending a few minutes checking on some essential things, you'll get the confidence you need to avoid major mistakes.

1. Check your emergency fund.
Now more than ever, having cash available is essential. Although three to six months of expenses is typically enough during normal times, saving more as an insurance policy against unemployment or other emergencies can help you sleep better at night.

2. Check your contributions.
Nobody feels good about putting money into the stock market when it's dropping like a stone. Yet when stocks are cheap, you should consider putting more money than usual into the market. By the time the current troubles end, you can expect share prices to be much higher -- so getting in while the getting's good will likely prove to be the smartest move.

3. Check your allocation.
If the falling market has convinced you that you're not as risk-averse as you thought you were, then leaving your asset allocations alone may work best for you. Otherwise, though, the market drop has probably left you with a smaller-than-normal allocation to stocks. If you still have a long way to go before you need your savings -- and you can handle the current stress -- then rebalancing into stocks increases your risk but also increases your potential return when shares rebound.

4. Check on new opportunities.
If you've ever complained that a particular stock was too expensive, look again -- you might be surprised. Google fell below $400 last week to hit a two-year low, and Apple dropped under $100 for the first time since early 2007. Take a second look at stocks you've tracked in the past and see if they suddenly make sense again.

5. Check yourself.
As the market drops further, the urge to panic will build. Unfortunately, there's no easy solution for your losses: The only way to get that money back is to stay invested and look for better long-term results.

Bear markets are never easy. But in hostile market environments, losing sight of your long-term strategies is a surefire path to disaster. By panic-proofing your portfolio, you'll put yourself in a position to ride out whatever the market throws at you.

More on fear and loathing in the financial markets:

To learn more about resisting panic and investing for the long haul, tune in to our Rule Your Retirement newsletter. We'll show you how you can still retire successfully even in a bad market. With a free 30-day trial, there's no downside, so why not take a look today?

Fool contributor Dan Caplinger has managed to avoid the panic, at least so far. He doesn't own shares of the stocks mentioned in this article. Google is a Motley Fool Rule Breakers pick. Apple is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is dressing up like a princess for Halloween.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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