By Jonathan Clements Wall Street Journal Sunday “Getting Going” Column Sunday, December 5, 2004

With 2005 almost upon us, it's time to say goodbye to 1999.

Remember the late 1990s? For a painful reminder, many folks need look no further than their portfolio. In the final years of that decade, there was first the frenzy over stock-index funds that track the Standard & Poor's 500 and then the euphoria over technology companies, especially Internet stocks.

But those who loaded up on these investments paid dearly for their enthusiasm. Over the past five years, S&P 500 index funds are off roughly 10%, while technology-sector funds are down more than 50%.

Need to get your portfolio back on track? Thanks to the market's recent gains, undoing your mistakes may suddenly seem a whole lot easier.

Getting Even

Among investors, there's a well-known tendency to "get even, then get out." We hate to sell at a loss, because that means admitting we made a mistake, with all the associated pangs of regret.

Almost five years after the bear market began, most stock investors aren't anywhere near break-even. The Dow Jones Industrial Average remains 10% below its early 2000 peak, the S&P 500 is off 22% and the Nasdaq Composite Index is down a staggering 57%.

That said, we have had a pretty good run since the October 2002 market low, with gains of 45% for the Dow, 53% for the S&P 500 and 93% for the Nasdaq. Those gains, plus the passage of time, have salved many of the bear market's emotional wounds.

"Investors hate like heck to take a loss," says Adrian Mastracci, a fee-only investment adviser at KCM Wealth Management in Vancouver. "During the bear market, they did nothing. They just closed their eyes and rode it all the way down. But now they've had a bit of a bounce back, it makes it more palatable to reorganize their portfolio."

The market's rebound hasn't just erased part of the bear market's loss. It has also bolstered investors' confidence. As our portfolios make money, we attribute those gains to our own investment savvy. That gives us the confidence to dump our losers and buy new investments.

If you need to revamp your portfolio, however, be careful not to repeat your earlier mistakes. In particular, you don't want to buy another random collection of investments.

Mr. Mastracci often finds that sort of mishmash when he analyzes new clients' portfolios. "What you see are the flavors of the day from the past five or 10 years," he says. "They don't have a game plan. Before you do anything with your portfolio, you should ask, 'What do I want my portfolio to look like?'"

Getting Organized

As you try to put together a more prudent investment mix, start by thinking about how much risk you can stomach, because that will drive your portfolio's stock-bond split.

This risk assessment is trickier than it seems. The problem: Our taste for risk rises and falls with the market. That is why investors who were loading up on stocks in early 2000 were dumping them at fire-sale prices 30 months later.

"In the 1990s, people felt they were masters of the universe," says Meir Statman, a finance professor at Santa Clara University in California. "By late 2002, they felt they didn't control anything. Now, people are more realistic."

Because it's so difficult to get a handle on our risk tolerance, Prof. Statman suggests a slightly different approach. His advice: Divvy up your money based on two financial goals, "getting rich" and "making sure I'm not poor."

You might invest the "get rich" portion in stocks and riskier bonds, such as high-yield junk bonds and emerging-market debt. Meanwhile, stash your "not poor" money in more-conservative investments, like high-quality bonds, certificates of deposit and money-market funds.

Getting Familiar

Investors tend to favor the familiar, such as their employers' stock, local companies and the shares of big blue-chip corporations. That phenomenon helped spur the explosion in S&P 500 indexing during the late 1990s, as investors were drawn to the index with its comforting array of familiar blue-chip stocks.

I, of course, am a fan of index funds. But there is a lot more to indexing than buying the S&P 500. As part of a well-diversified stock portfolio, you should also own index funds that track smaller U.S. companies, real-estate investment trusts and the stock markets in both developed and developing nations.

Investors are usually reluctant to buy into these unfamiliar sectors. But right now, they may find them a little less scary. The reason: Smaller U.S. companies, REITs, developed foreign markets and emerging markets have lately all fared better than the S&P 500.

To be sure, buying after a sector has performed well makes less investment sense, because the earlier gains effectively borrow from the future.

Still, small stocks, foreign shares and REITs are all key building blocks in a well-diversified portfolio. If the recent strong performance makes people more comfortable buying into these sectors, it seems like a small price to pay.

Getting Going

Still finding it hard to fix your portfolio? Try three tricks. First, when unloading your losers, sell some winners at the same time.

"From a tax standpoint, the smart thing to do is to realize your losers and leave the winners alone," Prof. Statman says. "But from an emotional point of view, you might want to sell both winners and losers. By pairing the trades, you lessen the pain of selling the losers."

Second, for every losing investment, find yourself a scapegoat, like your broker, or your brother-in-law, or your favorite personal-finance columnist. "Never forget that you can reduce the pain by blaming somebody else," Prof. Statman quips.

Third, commit to showing your year-end brokerage and mutual-fund statements to a family member or a close friend. Faced with the prospect of having others scrutinize your portfolio, you will have a powerful incentive to ditch your foolish investments and replace them with a sensible mutual-fund mix.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.