4 Smart Solutions for a Risky Portfolio

It's too early to tell whether the worst of the bear market has passed or is still yet to come. But regardless, after a major recovery that has sent stocks up nearly 30% from their recent lows, now's a good time to catch your breath and make sure your portfolio will act the way you want it to going forward.

If you've made it through the worst of March's stomach-churning drop without panicking, then you've done well. The worst time to try to make major changes to your investment strategy is immediately after a big market drop. Now that the markets have calmed down, though, you can afford to make some changes in your asset allocation without selling out at the worst possible moment.

As you review your portfolio, here are a few things to be on the watch for:

1. Buy the right beta.
Many investors got shocked last year when their stocks plummeted even more than the overall market did. That's the downside of high-beta stocks, which tend to have larger percentage movements than major market indexes. When stocks are rising, owning high-beta stocks can boost your returns -- but the price you pay is a bigger loss when times are tough.

For instance, take a look at how these high-beta stocks have performed recently:

Source: Motley Fool CAPS.

In contrast, low-beta stocks like Clorox (NYSE:CLX) and Hershey (NYSE:HSY) aren't likely to give you your next 10-bagger, but they have managed to hold their value better during the bear market.

But if you're willing to take the risk of bigger losses in the hopes of greater rewards, you shouldn't eliminate high-beta stocks from your holdings entirely. Just be aware of the greater volatility you'll see in your portfolio.

2. Diversify.
Diversification has fallen out of favor somewhat during this bear market. Whether you're talking about foreign stocks or U.S. stocks, big companies or small ones, most stocks lost substantial amounts of their value. And while government bonds have done extremely well as a hedge against a bad stock market, those bond investors who chose corporate bonds weren't as lucky in 2008.

Nevertheless, don't fall into the trap of believing that diversification will never work again. Although a focused portfolio gives you the best chance of huge gains, you also run a much bigger risk of taking big losses. Find the mix you're comfortable with, knowing the chances you're taking.

3. Consider a conservative approach.
Too many people think they either have to be entirely in the market or entirely out of it. But there is a middle ground. One way to split the difference is in conservative funds that tend to focus on a mix of income-paying stocks and bonds.

Obviously, these funds won't give you a huge payoff if the market recovers. But they've helped investors limit their losses over the past year, and they represent one of the few Morningstar categories of funds holding U.S. stocks with a positive return over the past five years.

4. Protect yourself.
If you think a stock you own might fall but you don't want to sell, you still might want to protect yourself against a major downward hit in the stock price. By buying put options, you can insure against exactly that kind of adverse move.

Even though somewhat decreased volatility has brought put option prices down from their high levels of last November and earlier this year, they can still be costly. Nevertheless, for peace of mind and protection against a big crash, you may find them worth the expense.

The bear market has reminded everyone that you need to manage your portfolio risk actively. Even with the recent rally, it's important not to get greedy in thinking that stocks are certain to continue to rise. Only by remembering the lessons of the past 18 months will you avoid making some of the mistakes you may have already made.

For more on how to be a smarter investor, read about:

• Buying stocks with room to run.
• The best type of stocks to own.
• One stock that'll change everything.