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The Short Answer

How to Get Back Into Stocks Without Getting Burned

Dollar-cost averaging and avoiding overheated areas are key focus points for safe stock allocation.

Question: I grew concerned about the prospect of a double-dip recession back in the spring, and I pulled part of my portfolio out of stocks and put the money into cash. Now that the economy seems to be stabilizing, I'd like to get back into the market but am concerned that I've missed my opportunity. Any tips?

Answer: It's probably small consolation, but rest assured that your conundrum is a common one. While getting out of stocks in a dicey market environment can provide psychic relief, investors who do so often replace one worry with another nagging concern. For example, investors who once feared the market could get even worse and shifted away from stocks might now be asking themselves whether and when it's safe to get back into stocks. In the end, investors who jockey their portfolios' allocations often wish they'd made no changes at all.

So at the risk of turning this into a lecture about the perils of market-timing, my first piece of advice is to find a reasonable target stock/bond mix that suits where you are in your investing life and stick with it through good markets and bad. Once you've done that, you should plan to make only modest changes to rebalance and to increase your portfolio's share of conservative investments as you grow older. Such a long-term, strategic asset-allocation strategy won't offer complete protection when stocks are shaky, as they have been on several occasions during the past few years. But it is the only way to ensure that at least something in your portfolio is performing reasonably well at any given point in time, and it helps enforce discipline at times of market stress. (For a good discussion of the benefits of buy-and-hold investing over a tactical approach, check out my interview with Jason Zweig of The Wall Street Journal.) Morningstar's Lifetime Allocation Indexes showcase reasonable asset mixes for investors at various life stages and risk tolerances; our  Asset Allocator tool can help you arrive at an optimal stock/bond/cash mix that's customized to suit your own goals and portfolio holdings.

Once you've identified an appropriate target allocation for stocks, your next step is to gradually transition your portfolio to your target weightings by dribbling equal installments of cash into the market for a period of several months or more. True, such an approach will mute your gains if stocks head straight up from here. But if the market's trajectory is more erratic--and if history is any guide, that will be the case--dollar-cost averaging will ensure that you're putting new money to work when stocks are relatively inexpensive as well as when they're dear.

You didn't say how much of your portfolio you had moved to the sidelines. If it's a small percentage--say, less than 20% of your portfolio--it's fine to bring your portfolio in line with your targets during a period of six months or less. But if you've moved an even larger amount into cash, you'll want to do so over a longer time frame of a year or so, to further smooth out your purchase prices and reduce the risk that you'll buy in near a market high. Contact your fund company or brokerage firm to automate your stock purchases, thereby limiting the odds that you'll chicken out and not go through with your investing program if stocks get rocky.

You raise a legitimate concern about missing what has turned out to be a good run for stocks. To avoid buying into potentially overheating areas, I'd be particularly deliberate and careful about deploying money into those pockets of the market that have enjoyed the biggest runups during the past year, including emerging markets and real estate. This table provides a quick overview of which market segments have been on fire.

Morningstar's Market Fair Value graph, meanwhile, provides a good compass as you're deciding where to deploy new cash. Harnessing the bottom-up research of Morningstar's equity analysts, the graph shows that our stock coverage universe, in aggregate, has a price/fair value ratio of 1. That means that the companies the analysts cover, in aggregate, are trading roughly in line with our analysts' estimates of their fair values. That's not too encouraging, but when you dig below the surface, it's possible to identify market segments that still have upside potential. For example, the universe of companies that our analysts tag as having wide moats, or sustainable competitive advantages, is roughly 10% undervalued currently. That means it's an ideal time to upgrade the quality of your stock holdings and to do so at an advantageous price. Stock investors can use our  Premium Stock Screener to home in on wide-moat firms that are trading below our analysts' fair value estimates, and I offered up some wide-moat mutual fund ideas in this article.

See More Articles by Christine Benz

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