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If you've stuck it out through the bear market without panicking yet, you've already done a great job defending your long-term investing plan from harm. Yet in order to take full advantage of the downturn and position your portfolio for maximum gains going forward, you have to take the next step.

Those who use asset allocation models to guide their investing know the benefits of committing certain percentages of their portfolio to different types of assets. When markets move violently, however, it's easy for those percentages to get out of whack. And while it's tempting to do nothing and let a market recovery return your allocation percentages to normal, missing out on an opportunity to rebalance means you're leaving potential gains on the table.

Rebalancing and the bear
One of the hot topics right now on our Motley Fool Rule Your Retirement discussion boards is whether rebalancing in a bear market really makes sense. On one hand, a huge move in stocks can leave your portfolio balance seriously out of whack, especially if you had a relatively high percentage of your money in stocks.

Consider, for instance, the past year. With the stock market down roughly 40% this year and Treasury bonds up as much as 34%, a portfolio with an 80/20 mix of stocks and bonds a year ago now has less than 65% of its value in stocks. Meanwhile, by not only preserving capital but also eking out a reasonable gain, your bond allocation has nearly doubled.

Ordinarily, this would look like an obvious time to rebalance. But risk-averse investors may wonder whether rebalancing now is really a smart move. After all, if stocks are going to rebound anyway, is there any point in rebalancing? Won't the market rebalance for you?

Buy low, sell high
If you've had all the risk you can stand, doing nothing isn't the worst strategy. But if you can stomach making a move right now, rebalancing your portfolio gives you a chance to buy stocks low while selling bonds at their highs.

As a simple example, consider you had a portfolio that consists of a single stock and some cash. You set up your investments so that last year at this time, you had 50% of your money in the stock and the other half in cash.

A year later, look how far out of balance your portfolio would be if the stock you'd chosen had been one of the following:

Stock

1-Year Return

Current Stock/Cash Allocation

Adobe (Nasdaq: ADBE  )

(47.5%)

34/66

Activision Blizzard (Nasdaq: ATVI  )

(34.0%)

40/60

EMC (NYSE: EMC  )

(42.5%)

37/63

3M (NYSE: MMM  )

(32.3%)

40/60

Pepsi (NYSE: PEP  )

(28.3%)

42/58

Walgreen (NYSE: WAG  )

(31.3%)

41/59

BP (NYSE: BP  )

(35.0%)

39/61

Source: Yahoo! Finance.

Now say that over time, your stock recovers to its 2007 value. That might take several years in a slow advance, or a much shorter time if a new bull market starts. If you don't rebalance, then when your stock reaches its year-ago level, your portfolio will be worth the same as it was last year.

But if you rebalance now, you'll have bought shares at much lower levels. Depending on which stock you buy, your investment will have risen in value greatly -- between 40% and 90% based on the examples above.

Gathering your courage
Obviously, after suffering the losses that many investors have seen in the past year, it takes guts to add even more to your stock position. Yet for long-term investors, it really is a no-brainer. If you were buying stocks throughout the last bull market, you were typically paying higher prices than what you're seeing now. In many cases, stocks were much more expensive -- yet you cheerfully bought shares regularly.

If you're tempted to stop buying now, ask yourself why. Specifically, why did you pay so much more for shares if you're not willing to buy them now for less? If you have a good answer, then you probably own the wrong stock -- but that doesn't mean you should give up on all stocks. Find promising companies selling at bargain prices and keep investing. In the long run, you'll look back on this period as the time when you made the most progress toward your financial goals.

For more on investing in difficult markets, read about:

Our Rule Your Retirement newsletter is much more than just a monthly newsletter. You'll get midmonth updates, constant feedback on discussion boards, and much more. Read more about this topic and see everything Rule Your Retirement has to offer with a free 30-day trial today.

Fool contributor Dan Caplinger is doing everything he can to boost his returns. He doesn't own shares of the companies mentioned in this article. PepsiCo is a Motley Fool Income Investor selection. 3M is a Motley Fool Inside Value pick. Activision Blizzard is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy gives you a boost.


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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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Related Tickers

9/23/2014 12:19 PM
ADBE $68.04 Up +0.84 +1.25%
Adobe Systems CAPS Rating: **
ATVI $21.44 Down -0.25 -1.15%
Activision Blizzar… CAPS Rating: *****
BP $45.86 Down -0.27 -0.59%
BP p.l.c. (ADR) CAPS Rating: ****
EMC $30.00 Up +0.32 +1.08%
EMC Corp CAPS Rating: ****
MMM $145.20 Down -0.51 -0.35%
3M CAPS Rating: ****
PEP $93.17 Down -0.42 -0.44%
PepsiCo CAPS Rating: ****
WAG $61.60 Up +1.18 +1.95%
Walgreen Company CAPS Rating: ****

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