For establishing a strategy that tempers potential losses in a bear market, the investment community preaches the same thing that the real estate market preaches for buying a house: "location, location, location".

Diversification is a battle cry for many financial planners, fund managers, and individual investors alike. When the market is booming, it seems almost impossible to sell a stock for any less than the price at which you bought it. When the indices are on their way up, it may seem foolish to be in anything but equities. But because we can never be sure of what the market will do at any moment, we cannot forget the importance of a well-diversified portfolio (in any market condition).

Looking Back - a Lesson in the Importance of Diversification
With the luxury of hindsight, we can sit back and critique the gyrations and reactions of the markets as they began to stumble after the '90s. Things began with what was first thought of as nothing more than a hanging thread off the mighty (and expensive) coat of the Nasdaq. Soon, however, the thread was pulled and began to take with it a sleeve, a pocket and both lapels. When the tech markets turned ugly, everyone seemed willing to blame the "new economy" players for overspending and forecasting unachievable projections. So, many investors moved to the more established technology brand-names, still seeking better-than-average returns. But things continued to unravel, and even the mightiest of tech names were getting demolished. But why? They had revenues - heck, they even had profits. But still the staples of the technology community were getting punished.

The Flight to Quality
As any stock with a four-letter (Nasdaq) ticker symbol seemed to show signs of smoke (or was completely engulfed in flames), investors thought the next logical stop was to move capital to the behemoths of the markets: the large-caps on the New York Stock Exchange, the companies with one or two-letter ticker symbols, the firms that once served as the cornerstones of our economy and are often synonymous with our industrial growth and prowess. We were sure that these companies were impervious to the declines we had witnessed on the Nasdaq. They were after all "real companies" with a business model everyone could understand. This move, while insulating to some degree, was still cause for concern as the equity markets in general were facing extreme scrutiny from investors.

What Could Have Been Done?
Diversification is not a new concept. We should remember that investing is an art form, not a knee-jerk reaction - the time to practice disciplined investing with a diversified portfolio is before diversification becomes a necessity. By the time an average investor "reacts" to the market, 80% of the damage is done. Here, more than most places, a good offense is your best defense, but even the right portfolio may not always be able to prevent losses or even soften the blow. But, in general, a well-diversified portfolio combined with an investment horizon of three to five years can weather most storms. Here are some diversification tips:

• Equities are wonderful, but spread the wealth. Don't put all of your investment in one stock or one sector. Create your own virtual mutual fund by investing in a handful of companies you know, trust, and perhaps even use in your day-to-day life. People will argue that investing in what you know will leave the average investor too heavily retail-oriented, but knowing a company or using its goods and services can be a healthy and wholesome approach to this sector.
• Consider adding index funds or fixed-income funds to the mix. Investing in securities that track various indices make a wonderful long-term diversification investment for your portfolio. By adding some fixed-income solutions, you are further hedging your portfolio against market volatility and uncertainty.
• Add to your investments on a regular basis. Lump-sum investing may be a sucker's bet. If you have $10,000 to invest, utilize the technique called dollar-cost-averaging. This approach is used to smooth out the peaks and valleys created by market volatility: you invest money on a regular basis into a specified portfolio of stocks or funds.
• Know when to get out. Your long-term investments should not be your short-term investments gone awry. Buying and holding and dollar-cost-averaging are wonderful strategies with which to interact with the markets for a long period of time. But just because you have your investments on autopilot does not mean you should ignore the forces at work. Stay current with your investment and remain in tune with overall market conditions. Know what is happening in the companies in which you own stock.
• Keep a watchful eye on commissions. If you are not the trading type, understand what you are getting for the fees you are paying. Some firms charge a monthly fee, while others charge transactional fees. Be cognizant of what you are paying and what you are getting for it. Remember, the cheapest choice is not always the best.

Investing can (and should) be fun. It can be educational, informative and rewarding. By taking a disciplined approach and utilizing the diversification, buy-and-hold and dollar-cost-averaging strategies, you may find investing rewarding even in the worst of times.

Keep an eye on your future.

by Peter Breen, (Contact Author | Biography)