Do This Today; Boost Your Returns Tomorrow

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:

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:

• How you can get your retirement back.
• Stocks that are tailor-made to survive a bear market.
• The best stocks you might actually buy.