In its most recent survey of corporate pension accounting, Hewitt reports that the average assumed long-term rate of return at year-end 2008 is 7.98%.  That’s the number that companies estimate they'll earn annually on their pension investments; they use that guess to help decide how much they must invest today to pay future benefits. While  7.98% is  lower than the 8.34% assumed rate in 2004, it  still seems a tad optimistic when viewed through “new normal” binoculars. Stocks aren’t expected to earn much more than 8%, and there’s little reason to expect bonds will post returns beyond their 5% historical long-term average. (In fact, given where we are in the interest rate cycle, 5% might be optimistic.)

Even before the credit crisis fallout, there was plenty of skepticism about corporate pension assumptions. In the 2007 Berkshire Hathaway shareholder letter Warren Buffett stepped through yet another of his clear-eyed market/math lessons that pointed out the long-term trend is for stocks (net of expenses) to earn around 7% and bonds 5%.  Plug that into a 70/30 stock-bond mix (typical for pension funds) and you get a return closer to 6.5% than 8%.

I am going to leave the world of pension funding/underfunding and switch gears to what matters more for many of us: The rate of assumption we have for our self-managed 401(k) and IRA retirement assets. After  all, most of us aren’t covered by traditional pensions. And that leads me to ask the question: What’s your assumed rate of return? (See the poll below.)

Beware of the “garbage in, garbage out” trap. The higher the rate you use, the higher the risk you run of falling short. First off, there's the problem of high expectations falling short of real-world returns. Second, when you assume a high rate of return it often becomes an excuse to contribute less. And to be sure, after the 18% annualized gain for the S&P 500 in the 1990s it was easy to assume the markets would do most of the heavy lifting for our retirement.

Consider how different rates of return would impact a $250,000 retirement portfolio today. (Assume no additional contributions.)

In 15 years, the $250,000 would be worth:

•    $2.99 million @ 18% assumed rate.
•    $1.04 million @ 10% assumed rate
•    $793,000  @ 8% assumed rate
•    $643,000 @  6.5% assumed rate

So, what rate are you banking on? To see the impact of different assumptions, check out this calculator where you can adjust your contributions and assumed rate of return. And keep in mind the advice of Steve Utkus, chief of Vanguard’s Center for Retirement Research:  “Contributions need to be higher than many of us imagined. Markets, averaged out over good and bad periods, are now recognized to play a smaller role.” Are you ready to pony up more?

The safety of municipal bonds is often taken for granted. After all, the theory goes, if a state or city runs short on cash, it can always tax the heck out of its constituents to make up the shortfall. Corporations, on the other hand, don't have that kind of fallback.

But California's recent budget troubles have thrown the default possibility back into the limelight. And that might have you wondering if you should bail out before yet another theoretically safe investment proves to be not so secure after all.

If you haven't been paying attention, California seems to keep getting closer and closer to default, and its government can't decide how to clean up the mess. Fitch Ratings recently downgraded the state's bonds to the worst in the country (which happens to be A-, a rating many corporations would kill for). While the spokesman for California's Treasury department says a default "won't happen," could you ever imagine a Treasury spokesman saying default was "kind of a possibility"?

"I'll be bankrupt"?

Let's start off this discussion with what should be your central question: "What do I have to lose?"

In the case of muni bonds, the answer is "Not much." For one, single-A rated municipal bonds have a historical default rate of 0.0084%. That is, only about 1 in 12,000 defaults over a 10-year period.

But let's say you hit that unlucky jackpot. Your state says, "To heck with our creditors. We don't care if we won't be able to borrow money again for years," and refuses to pay. Then what do you have to lose? The answer still is, "Not much." In fact, according to the Wall Street Journal, in the Great Depression, while more than 15% of muni bonds defaulted, the estimated loss rate for investors was 0.5%. When Orange County, Calif. defaulted in 1994, investors actually got all of their money back.

And here's what you have to gain: Right now, 5-year muni bonds are yielding 2.14%, which is the same as 2.97% if your income is taxed at 28%. That's compared to a 2.44% yield on 5-year Treasury bonds.

Let's say you're weighing the purchase of a 5-year muni bond in its typical, $5,000 denomination against the purchase of a risk-free Treasury bond. Are you willing to risk a 1 in 12,000 possibility that you lose $25 (0.5% of $5,000) for the 11,999 in 12,000 chances of making an extra $125 over 5 years?

For me, the answer is yes. But if the 0.0084% chance of a $25 loss from a default frightens you, buy a municipal bond mutual fund that can mitigate your risk even more, such as the Fidelity Intermediate Municipal Income fund (FLTMX). Mutual funds will have other risks attached. If interest rates rise, fund prices can fall, causing you a larger loss. But in exchange, you'll lose little money even if one of the fund's bonds is completely wiped out.

Now, you could argue that there are even greater opportunities in stocks and corporate bonds, since virtually risk-free assets like Treasuries and municipal bonds aren't offering much income right now. That aside, muni bonds still look like a better bet next to those issued by the U.S.A.

Treasury yields have been on a tear lately. Unfortunately for people with Treasury bonds already in their portfolio, that means that the prices of their holdings have dropped like a rock. If investors continue to gain confidence in the stock market, you can expect that trend to continue. You might have used Treasury bonds as a bomb shelter during the market panic. But now, your savior in 2008 could be turning against you.

If the Treasury market continues to weaken, a few notable investors might be saying, "I told you so." Warren Buffett predicted a Treasury collapse in his annual letter to shareholders several months ago. "When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he wrote. "But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

What can you do about it? First off, if you panicked and put your money in Treasury bonds earlier this year, pare your bond holdings back to a percentage that's right for your age. (If you don't know what it should be, see Money's asset allocation tool.) If you're still too nervous to take risks on stocks, you can move the money to a short-term bond fund, such as the Vanguard Short-Term Bond index (VBISX), which is one of Money's picks. A short-term bond fund might still have heavy investments in Treasuries (as the Vanguard fund does), but since the bonds' maturity dates arrive soon, the funds' share prices won't drop as much as funds invested in long-term Treasury bonds.

Even if you stayed the course last year and didn't binge on Treasury bonds, many of the mutual funds that you rely on for diversification could have. The fund doesn't have to have "Treasury" in its name to be vulnerable. A fund that simply tracks a bond index, such as the Vanguard Total Bond Market index (VBMFX), will have a full 25% of its portfolio invested in Treasury bonds.

To see how much of your portfolio is exposed to Treasury bonds, use a website such as Morningstar.com that will break down how a fund is invested. Here's an example using the Vanguard Total Bond Market Index fund referenced above. Under the "Sector Weightings" heading is what percentage of a fund's assets are in U.S. Treasuries. You probably don't want to cut Treasuries out altogether, but don't have more of your bond portfolio in Treasuries than you'd have if you invested in a bond index fund. Right now, that sets the ceiling for Treasuries at about 25% of your bond portfolio.

Treasury bonds' pullback might prove to be temporary, but if Buffett's right, you'll be glad you limited the damage.

How are you dividing your pie?

According to the most recent AAII Asset Allocation survey, the percent of direct investments in individual stocks is at an all-time low of 17%, nearly half the historical average of 31%. (By comparison, during the depths of the 2000-2002 bear market the percentage invested directly in stocks hovered in the vicinity of 25%.)

What’s interesting is that that the percentage in stock funds right now-27%-is pretty much in line with its long-term average of 29%. So what’s going on? The steadiness of the stock fund number is probably a function of individuals keeping up with systematic 401(k) investments; new contributions into stock funds counteracting to some extent the market losses in those stock fund accounts. As for the decline in direct stock investments, well, clearly we’re a bit less eager to commit new money to stocks.

None of that is too surprising, but what really caught my eye is the fact that the current 16% allocation into bond funds is double the historical norm, while the 6% allocated to direct investments in individual bonds is barely off its 7% historical average. If your goal is to increase your bond allocation and you’re only investing via a 401(k) and your 401(k) only offers bond funds, then you’ve got no choice in the matter. But if you do have the flexibility to buy bonds rather than bond funds, my colleague Joe Light pointed out in a recent article that direct investments in bonds can be the better route.

The knock against bond funds is that because a fund is constantly buying and selling bonds there is no guarantee that you will not lose money. If you instead own an individual bond and hold it to maturity, you will get all your money back (plus interest) assuming the issuer doesn’t go belly up. That doesn’t mean bond funds are bad. They are indeed a very viable option-especially if you have less than $100,000 to sink into the bond portion of your portfolio. But check out Joe’s article for tips on how to invest directly. It definitely takes more time and effort, but you gain the peace of mind that your fixed income allocation won’t lose money.

– Carla Fried

A market dip in the years before retirement can be scary, but bailing out of stocks isn't the answer. Here's how to make sure you're still on track.

Question: I am 61 and plan to retire in about eight months. Given the current market, do you think I should withdraw some or all of my 401(k) money and put it in a safe place that is covered by FDIC insurance? This is part of my retirement income. —Peggy Wagstaff, Marietta, Georgia

Answer: There’s no doubt that the older you are and the closer you are to retirement, the more frightening the current economic crisis is. After all, if you’re ready to retire or have already called it a career, you simply don’t have as much time to wait for stock prices – and your 401(k) account balance – to rebound.

If you’re drawing money from your retirement portfolio for income and your investments are dropping in value, the double-whammy of withdrawals and losses leaves you with less capital to participate in the market’s recovery, increasing the chances that you may run out of money later in retirement.

But moving your 401(k) stash and other retirement savings into safe options like CDs, a stable value fund or a money-market fund isn’t the right response.

What you really need to do is give yourself a more comprehensive retirement check-up that looks not just at your 401(k) investments but also helps you figure out what other moves you may need to make to assure a secure retirement down the road.

Here are three steps you can take to make that broader assessment.

Coolly review your investment strategy

Hunkering down in the security of conservative investments may be emotionally appealing. But unless you’ve got a huge nest egg, the yields you’ll earn on such options are just too low to provide adequate income and maintain your purchasing power in the face of inflation over a retirement that could easily last 30 or more years.

So while the stock market may be the last place you want to put any of your retirement money right now, the fact is that you still need the long-term growth that equities have historically provided. The key is to get that growth without being pummeled too badly during market downturns.

One reason so many pre-retirees are hurting so badly now is that they went into this crisis with far too much of their retirement savings in stocks. In recent testimony [www.ebri.org] before Congress, Employee Benefit Research Institute research director Jack Vanderhei noted that nearly four out of 10  401(k) participants in their mid-50s to mid-60s had 80% or more of their account invested in stocks in 2006.

Hey, I’m an optimist when it comes to the long-term outlook for stocks. But unless you’re holding a big cache of cash or bonds in some other account, having 80% or more of your 401(k) in equities is just way too aggressive for someone already retired or nearing retirement.

Reasonable people can disagree about what the exact blend of stocks and bonds should be, but for anyone on the verge of retiring or already in the early stages of retirement, something in the neighborhood of 55% stocks and 45% bonds is more appropriate. As you age, you should cut back your stock holdings even more, until you’re down to 20% to 30% in equities by the time you’re in your 80s.

Determine whether your planned retirement date still makes sense

The key question you must answer here: Given your 401(k)’s current value, can you still draw enough from your account to live comfortably over the next 30 or more years without running out of money before you run out of time?

The only real way to know is to crunch the numbers. You must figure out how much income you’ll need to live comfortably in retirement and then see if you can realistically expect to generate that amount from Social Security, any pensions you may have plus what you can safely draw from your 401(k) and other retirement accounts.

Any decent financial planner should be able to help you with this sort of analysis. You can also do it on your own by going to an online tool like the Retirement Income Calculator in the Investment Guidance and Tools section of T. Rowe Price’s site.

Originally designed for people who were already in retirement, this tool has been re-tooled, so to speak, so that you can also use it if you’re still in the pre-retirement stage.

Plot a course of action

If you’ll have enough coming in to cover your living expenses, great. You can stick to your scheduled retirement date.

But if you’re coming up short – and I suspect many people will, given the toll the market’s decline has taken on retirement  accounts – then you’ll have to make some changes.

One option might be to retire on schedule but work part-time in retirement. Or you might decide to work a couple of more years. That would not only allow you to accumulate a couple extra years of saving, it would also give your portfolio a chance to recover.

And there’s another advantage to working a few more years: a bigger Social Security check. Each year you delay taking benefits beyond age 62, you get "delayed retirement credits" that can boost your monthly check by about 8% for each year you postpone up to age 70. Your Social Security check might go up even more because the extra accumulated wages can increase your benefit. You can see how much more you might receive by working a few extra years by going to Social Security’s new Retirement Estimator .

It’s crucial that you give yourself this sort of pre-retirement check-up before you leave a job that’s providing a good paycheck and decent health benefits. Otherwise, you may find yourself having to go back into the workforce where, as an older worker, you may have a hard time duplicating the pay and benefits package of your old employer.

Finally, whenever you eventually decide to retire, be sure to check in every year or two with a planner or calculator to assure that you’re not going through your retirement savings too quickly.

Starting with a modest initial withdrawal of around 4% of your retirement portfolio’s balance and then increasing that amount for inflation each year generally gives you about a 90% chance that your savings will last at least 30 years. But if your 401(k)’s value takes a big hit early in retirement and you don’t adjust your withdrawals, those odds can plummet.

So if you retire into a slumping market like this one, you may want to cut back your spending a bit so that your savings well doesn’t run dry late in retirement. After all, what could be more disconcerting than to realize that you’re in good enough shape to go another 10 or 20 years in retirement but your portfolio’s only healthy enough to make it another five?

iReport.com: What's your dream retirement?

Seeing your portfolio shrink can be tough so close to retirement, but you should still be investing for the long term.

Question: I'm 58 years old. At the beginning of June, my 401(k) was worth $482,000 and now it’s worth $430,000. How can I stop the bleeding? —John, Tyler, Texas

Answer: If your goal is simply to staunch the bleeding, the answer is simple. Just move all your money into your 401(k)’s money-market option. That will pretty much assure that your account balance will fall no further.

But I don’t think that should be your goal.

Why? Well, if you keep your money in your plan’s money-market option (or any guaranteed-return investment, for that matter), you’ll be relegating your retirement stash to a mediocre long-term return, which means that your nest egg isn’t likely to grow very much between now and the time you retire.

Of course, you could move it to a safe haven today with the idea of switching back to a portfolio of stocks and bonds at some point in the future. But you then have to figure out when the right time is to move it back. You don’t want to switch out of the money-market fund too soon and incur more losses. Yet if you wait too long, you can miss the big gains that come in the explosive early stages of a stock rebound.

So if stopping the bleeding isn’t the right goal, what should your objective be?

Pre-retirees like you who are in their mid-50’s to early 60’s and have 10 or so years to go before retiring ought to be pursuing an investing strategy that can generate enough growth to support them through a long retirement yet also provide enough downside protection to prevent a market setback from totally derailing their post-career plans.

Retirement home stretch investing plan

The heart of this strategy is coming up with a mix of stocks and bonds – asset allocation would be the technical term – that balances your long-term needs as a retiree against the short-term fluctuations of the market.

Although you may not think of it this way, even when you’re in the last stages of your career you are still actually investing for the long-term. It’s not as if your investing time horizon extends only to the day you retire. On average, a 65-year-old will live another 20 years or so, and the odds are good that you could live well into your ‘90s. So you still need long-term capital growth in your retirement portfolio to maintain purchasing power and assure you don’t outlive your assets.

At the same time, however, as you approach your retirement age, you can’t afford to take big hits to your portfolio’s value. You just don’t have as much time to bounce back from market setbacks as you did at the beginning or even the middle of your career. So while going for growth, you also need to protect the value of your savings.

You can argue about what constitutes the right stocks-bonds mix for a pre-retiree. Generally, though, someone your age should have roughly 60% to 65% of his retirement portfolio in stocks and the remainder in bonds. The stocks are there for long-term growth, the bonds for steady income and short-term protection. As you age, you would then gradually move more of your savings toward bonds, although even in your 80s and 90s, you likely want to keep 20% to 30% of your portfolio in stocks.

But this is a guideline. In fact, there is no “ideal” mix, one that’s guaranteed to give the best blend of protection and return. You’ll have to make a judgment call based on your own situation.

If you get really nervous every time the Dow takes a dive – or if you don’t have much in the way of resources beyond your retirement investments – you might want to stick to the lower end of this scale, or keep even less in stocks for that matter (although, remember, that will likely mean lower long-term returns and raise the odds that you could run through your savings).

Conversely, if you can tolerate swings in your portfolio’s value – or you have other resources to fall back on, such as a pension, sizeable home equity, etc. – then you could gravitate to the higher end of the scale. To see how different mixes might perform, check out the Asset Allocator tool at T. Rowe Price’s site.

Stomaching the ups and downs

It’s important that you understand that following the strategy I’ve outlined won’t protect you from any and all losses. But that’s not the point. Even at this later stage of retirement planning, it’s okay to suffer occasional setbacks. Indeed, you can’t avoid them if you want the long-term growth you also need. But the idea is to limit the size of those downdrafts so they don’t inflict irreparable harm.

You don’t say how your 401(k) is currently divvied up between stocks and bonds. But given the magnitude of the loss you’ve suffered since June (about 10%) compared to how the stock and bond markets have fared since then, I’d be surprised if you weren’t overloaded with stocks or invested in particularly volatile ones.

So I recommend that you re-assess your asset mix and bring it somewhere within the range I’ve laid out. Doing that won’t insulate you from all short-term setbacks. But it should increase the odds that your nest egg will be there to support you throughout your retirement.

When the market gets rocky, it can be especially hard on retirees who can't afford to wait out the bumps.  Give your portfolio a check up and make sure your investing strategy still works for you.

Question: My husband and I have been retired for five years. In just a few months our retirement portfolio of stocks and bonds has dropped in value from almost $500,000 to just over $400,000. Our broker says, “Hold on, it will come back soon.” But this is our retirement! We wonder if we should sell our investments and invest the proceeds in federally insured CDs. What do you think? —Anne, Huntsville, Alabama

Answer: First, let me say I totally understand your concern. After you’ve retired, seeing the savings you’re depending on to support you the rest of your life take a hit of nearly 20% can really rattle you, especially when there’s no guarantee that the slide might not end there.

But I don’t think moving your entire stash into CDs is the answer. While CDs do provide security of principal – assuming you take steps to assure they’re covered by FDIC insurance – they don’t offer very high returns these days, nor much long-term protection against inflation.

So although shifting your nest egg into CDs might provide short-term comfort, in the long run it may make it more difficult for you to maintain your standard of living in the face of rising prices later in retirement.

That said, I also don’t think the right answer is for you to automatically follow your broker’s recommendation and wait things out. Blindly following this advice when you’re clearly very fearful and conflicted about it wouldn’t make sense.

All of which is to say that I think you need to sit down with your broker and go over your overall investing strategy. And by strategy I don’t mean just an explanation of why your broker believes your investments will come back.

I’m talking about an in-depth discussion during which your broker explains how your savings are divvied up between stocks and bonds, outlines exactly what types of stocks and bonds you’re invested in and demonstrates why this is the right approach for you.

At the very least you want to know why your portfolio has lost almost 20%. That’s a big hit considering that over the past three months, the broad stock market has lost about 10% of its value on a total return basis and bonds have lost about 2%.

Of course, the market has been down a lot more than 10% several times this year, so maybe you’re measuring your loss over a slightly different time period. But either way, for the value of your portfolio to dip anywhere close to 20%, you would likely have to be invested pretty darn aggressively, particularly for a retiree. So you need to know the rationale behind this portfolio.

You and your broker should also talk about such issues as how much money you intend to withdraw each month from your savings to meet expenses, how many years you need your portfolio to last, what sorts of other resources you and your husband can tap (pensions, home equity, income from part-time work, etc.) and how much risk you’re willing to take.

But this shouldn’t be just a gabfest. Your broker should be able to give you a sense of how long your portfolio might reasonably last given the way your money is currently invested and how much you’re withdrawing each month.

I’m not talking about a guarantee. That would be unrealistic. But by using computerized simulations, your broker should be able to give you a reasonable estimate of the probabilities of your portfolio running dry based on different withdrawal rates and how well or badly the market performs.

Even more important, your broker should be able to run some alternative scenarios for you, showing how your portfolio’s longevity might change if you invest differently from what he’s recommended (for example, going into CDs).

In short, your broker needs to do a comprehensive review of your portfolio with you so you can decide whether the course your broker has mapped out still makes sense or whether you need to take a different tack.

The kind of analysis I’m talking about isn’t rocket science. Any competent adviser should be able to do it. You can also do a simplified version of your own using online tools.

So I recommend you and your husband contact your broker and then go through the sort of exercise I’ve outlined above. If your broker can’t or won’t do this – or you don’t have confidence in the analysis you get – then you may want to search for a new adviser who can help you arrive at a more acceptable investing and retirement income strategy, and who’ll respond with more than bromides when things go wrong.

Treasury Inflation Protected Securities seem logical in today’s market, but make sure you have a diversified, long-term strategy and don’t overload.

Question: Are TIPS a good investment today since we are facing inflation? There seems to be a lot of discussion about them, both pro and con.—Hans, Nashville, Tennessee

Answer: That depends. If by “good investment” you’re asking whether TIPS – or Treasury Inflation Protected Securities – can shield a portion of your assets from inflation then the answer is yes.

After all, that’s what TIPS are designed to do. They pay a fixed coupon rate of interest that’s lower than that of regular Treasury bonds. But the principal, or face value, of TIPS is adjusted to keep pace with changes in the consumer price index. The result is that as the CPI rises, so do the interest payments and the face value of your TIPS, giving you a sure hedge against inflation.

But if by “good investment” you are asking whether you should load up on TIPS in hopes of ratcheting up your returns by capitalizing on investors’ growing inflation fears, then my answer would be no.

Why? Well, for one thing I don’t think it ever makes sense to dramatically overhaul your portfolio to protect yourself from one particular threat or capitalize on one specific opportunity. If you’re wrong you can take a beating. You also run the risk of ending up as one of those investors who spend their time looking for the next big score, but who are more likely sabotaging themselves with lousy timing and onerous transaction fees.

And in the case of TIPS, there’s another reason this isn’t a good time to think of making a killing in them: they appear to be pretty richly priced.

As inflation fears started to pick up late last year, investors began pouring money into TIPS, driving up their prices and lowering their yields. Recently, the “real” yield on 10-year TIPS—that is, the percentage they pay above inflation—was hovering around 1.4%, quite a bit lower than the average of 2% since TIPS were introduced in 2003.

Another way of looking at that yield is to compare it to the recent yield on regular 10-year Treasuries, which, at 4.0%, was 2.6 percentage points higher than that of TIPS. Essentially, this means that for you to do better in TIPS than in regular Treasuries, inflation would have to exceed 2.6% a year for the next 10 years. That’s hardly impossible. But that margin is typically more like 2.3 percentage points, which means that at current prices TIPS already reflect higher inflation expectations than in recent years.

I’d also add that while TIPS are the surest way to hedge against inflation, there are other investments to consider, including REITs and funds that invest in natural resources and commodities.

And let’s not forget—dare I utter the word given the beating they’ve taken this year?—stocks. It’s important to understand the way in which stocks provide protection from inflation. They’re not a hedge in the sense TIPS are. Indeed, if anything, rising inflation expectations tend to drive stock prices down.

Over long run, however, stocks tend to generate the highest inflation-adjusted returns. From 1926 through 2007, for example, large-company stocks beat inflation by roughly seven percentage points annually compared with about 2.3 percentage points for intermediate-term government bonds and less than a percentage point for Treasury bills.

I’m sure I don’t have to mention that those performance stats come with a few big caveats. But I will. Those results aren’t guaranteed, the margin could very well be a lot smaller in the future and stocks can run into some severe setbacks, as they have recently.

For more on how to build a portfolio that provides a decent measure of protection against inflation but also incorporates stocks’ long-term growth potential, I suggest you check out the Inflation: 4 Ways to Protect Your Assets story in Money’s July issue.

If after reading it, you want to add some TIPS to your portfolio, you have two choices. You can buy a mutual fund that specializes in TIPS (and we just happen to have such a fund on our Money 70 list of recommended funds). Or you can buy TIPS directly from Uncle Sam.

If you plan to use TIPS primarily as a diversification tool as opposed to spending the income, I think you’ll find the mutual fund route more convenient and practical. The fund will automatically reinvest the income, plus owning a fund will make it easier for you to rebalance your portfolio. Rebalancing will also assure that you’ll end up with TIPS at a variety of prices, as you buy or sell shares over the years to maintain the target percentage of your portfolio in TIPS.

One final note. You’ll be taxed on the inflation adjustment to your TIPS’ principal even though you don’t reap that gain until the TIPS mature or you sell them. So to avoid having to fork over taxes on those gains, you’re better off holding TIPS in tax-advantaged accounts like a 401(k) or IRA.

It's easy to want to play it safe with a large chunk of cash. But being too safe can be a big risk.

Question: I’m 49 years old and have about $1 million to invest. My mother has advised me to put it all in 30-year muni bonds and CDs, but I wonder whether I ought to be more diversified. Do you think I should take my mom’s advice? —C. Hilliard

Answer: Normally, moms are a font of good common-sense advice, encouraging us to eat our vegetables, play nicely with others and, of course, imparting that time-honored admonition: “Don’t run holding that stick. You’ll poke your eye out!”

But as much as I hate to do it, I’m afraid I have to tell you that you should ignore your mom’s investing advice, which is bad on several levels.

Take her muni bond recommendation. Sure, bonds should be part of a well-balanced portfolio and, depending on your tax rate, munis can be an excellent way to get that exposure in taxable accounts, especially today when muni yields are competitive with those of Treasury bonds in many cases, even without factoring in munis’ tax benefits.

But by investing solely in long-term munis – as opposed to also holding short- and/or intermediate-term bonds – you are taking a big risk. The threat isn’t that the bonds might default. As long as you stick to high-quality munis the chances of that are actually pretty slim. Rather, the problem has to do with the seesaw relationship between interest rates and bond prices – namely, when interest rates rise, bond prices fall. And generally the longer the maturity, the steeper the drop.

I’m not in the business of making interest-rate predictions. But given all that Big Ben Bernanke and his colleagues at the Fed have been doing to stimulate the economy, I don’t think it’s a stretch to wonder whether we might be in for higher inflation and higher interest rates at some point in the near future.

But whatever the outlook, I still think it’s best to hedge your bets by sticking to bonds, or bond funds, with maturities at the short- to intermediate-end of the maturity spectrum. You’ll collect most of the yield of longer-term issues with much less volatility.

But the even bigger problem with mom’s recommendation is that it would leave you with all of your money in fixed-income investments. That might be fine if you were, like, 90 years old. (Even then, 100% in fixed-income wouldn’t automatically be the way to go.) But you’re a mere youngster of 49, for goodness sake. At this point in your life, you still need some long-term growth to boost the purchasing power of your portfolio so it can support you throughout retirement. And to get that growth, you’ve got to diversify into stocks.

So the challenge you face is putting together a diversified portfolio of stocks and bonds that gives you a decent shot at long-term growth but also provides enough stability so that your portfolio won’t get totally hammered if the stock market drops or interest rates rise.

In order to meet that challenge, you’ll have to grapple with two fundamental questions: How should you divvy up your holdings between stocks and bonds? And then, which types of stocks and bonds should you invest in?

There are no one-size-fits-all answers. It largely comes down to how much risk you’re willing to take, what size returns you want to shoot for and how hard you want to work at creating and then monitoring your portfolio. But you can get advice both on how to allocate your holdings between stocks and bonds as well as on specific investments by checking out this month’s Money cover story, "The Only 7 Investments You Need Now."

I’ll leave it to you as to the best way to handle your mother if she asks you whether you followed her advice. But there is a way you can be truthful but also let her down easy. Just say, "Remember, mom, how you always told me to eat a balanced diet? Well, I’m applying your excellent advice to my investment portfolio."

Are you prepared for a financial emergency?

With a recession and rising inflation, it's more crucial than ever to have a six to 12-month living-expense cushion in cash for an emergency. Don't have it? Drop us a line at makeover@moneymail.com. Include your name, age, city, state, marital status, occupation, how much you have in cash savings and retirement savings. Please send a photo of you (and your spouse, where applicable) too. 

This isn't the first, or the last time we've faced economic uncertainly, but with 30 or 40 years until retirement, there's no need to rush out of the market.

Question: I'm 28 and have my Roth IRA in a 2045 target-date retirement fund. In the last couple of months, I’ve lost almost an entire year and a half’s worth of profits. I want to keep contributing to my Roth, but I’m concerned about the possibility of recession and all that’s going on in the market. What do you think – should I try something else or just suck it up and keep investing in the same fund? –A.P., Crofton, Maryland

Answer: It’s perfectly natural for you to be anxious or even scared at times like this. Read the newspapers and you almost can’t help but come away with the impression that we’re in the midst of a total financial meltdown, an economic Armageddon, so to speak.

Combine this sense that the system is ready to come crashing down around us at any moment with the fact that the broad stock market is down about 15% from its peak last October and it’s no wonder you’ve begun second-guessing your decision to invest your Roth money in a target-retirement fund that, given your age, is probably about 90% or so invested in stocks.

But as much as I understand your urge to abandon your plan, I think it would be a mistake.

That said, I don’t think the solution is to just “suck it up.” That suggests a certain macho attitude that may have a place in certain sports, but isn’t really appropriate to investing. Ration and clear thinking are what’s needed to succeed as an investor.

Question: I’m 68, recently retired and have $250,000 to invest. I don’t know much about finances and I’m confused by all the information out there. I know I should diversify, but how do I determine where to put my money? –Grace, Yukon, Ohio

Answer: Well, you say you don’t know much about finances, but at least you know that you should diversify your $250,000 rather than plow it all into any one type of investment.

That’s a good start, especially given the precarious state of the financial markets today. People who went overboard on one asset class because it seemed like a sure thing just a couple years ago – real estate, financial stocks, whatever – are now paying the price, while people who take the same approach today with the hot investments du jour – gold and commodities come to mind – may end up paying the price tomorrow.

But as crucial as asset allocation is it’s still not as important as the factor you’re apparently overlooking: you.

That’s right, knowing all about building a well-balanced portfolio with different asset classes that work in concert with each other doesn’t mean anything if you haven’t first asked yourself what exactly you are trying to achieve by investing this money.

If this is an extra stash you probably won’t have to touch and will likely leave to your heirs, then you don’t have to worry so much about short-term losses and you may be able to invest more aggressively than is typical for someone your age.

If, on the other hand, you’re going to be drawing on this money for regular income to supplement Social Security, then you can’t afford to risk big setbacks because the combination of market losses and withdrawals can put a big dent in our portfolio’s value, raising the possibility that you could run through your two hundred and fifty grand too soon.

You’ve also got to take your emotional and psychological makeup into account. It’s one thing to say that you’re capable of riding out ups and downs in the market because you know that stocks usually generate the highest returns over the long run. But will you feel that way if the value of your holdings has dropped by 20% or 30%? Or at that point will you more likely be dumping everything you can and fleeing for the safety of CDs?

You can’t compensate too much on the side of safety, however, and just plow virtually all your money into CDs and money-market funds – unless you don’t mind the fact that the purchasing power of your money is likely to drop over the long-term after taxes and inflation.

I think that most people can sort through these issues and come up with a reasonable mix of assets that gives them enough upside potential to earn decent returns while maintaining sufficient downside protection against stomach-churning losses.

By answering a few simple questions about your risk tolerance, and how long you plan to have your money invested, for example, our Asset Allocator tool will suggest an appropriate mix of stocks and bonds. You can then go either to our Fund Screener or consult our Money 70 list of recommended mutual funds to find specific funds to fill that suggested mix.

If you’re going to be relying on your $250,000 for retirement income, I’d suggest you check out T. Rowe Price’s Retirement Income Calculator. You’ll get an estimate of how long your money is likely to last. You can then try different investment strategies and withdrawal rates to see whether your money lasts longer or goes sooner.

But, again, you’ve got to consider the “you” factor. If you feel overwhelmed when you start to deal with different investment alternatives or you’re just not confident about revving up calculators and the like, then you should probably get some professional help.

You’ve got several choices. You can hire a financial planner who can take a look at your overall situation, discuss your goals and come up with a plan. Typically, planners want an ongoing relationship, which means paying a certain percentage of your assets in fees each year (although some are willing to work on a flat-fee or hourly basis). Many large investment firms and mutual fund companies also give investment and planning advice these days.

Be careful, though. There are lots of people out there posing as advisers who are really peddling high-priced investment products or just looking to rip you off; $250,000 throws off more than enough scent to bring such opportunists and scam artists flocking to your door.

Whatever you do, don’t rush. Better to take some extra time and make a good decision that perhaps you could have made sooner than to move quickly and end up regretting that you did.

A diversified strategy and periodic readjustments will help you steer clear of market madness. Tune out all the noise and stick to the game plan.

Question: I generally review my portfolio twice a year to see if I need to make any adjustments. But given that the market has been down in recent months, I’m wondering whether I’m better off waiting until the market rebounds or sticking to my usual schedule. What do you think? –Todd M., Bryan, Ohio

Answer: I assume that when you talk about adjusting your portfolio twice a year, you mean that you’re rebalancing to bring your mix of stocks and bonds back to its original proportions.

And if that’s the case, then the strategy you’ve been following up to now makes perfect sense to me. As different investments earn different returns, your portfolio’s proportions will shift over time. So you periodically need to sell some shares of investments that have done relatively well and plow the proceeds into those that have trailed – or just funnel new money into laggards – to bring your portfolio back to its proper balance of risk vs. return.

Granted, one could argue about which of the many different rebalancing strategies available is the most effective. (I’m a member of the “once a year is enough” club myself, mostly because it’s easy and investors are more likely to stick with what’s simple.) But the most important thing is that you’re consistent – that is, you choose a method and then stick to it.

All of which is to say that I believe you ought to think twice – or maybe even three or four times – before you abandon your current strategy.

I can understand why you might have the urge to change your game plan. You’re no doubt hoping that by waiting a bit some of your battered investments will recover and you won’t have to realize losses.

But the whole point of building a mix of different types of assets based on your goals, time horizon and risk tolerance, and then rebalancing back to that blend on a regular basis is that you can’t predict the future. You don’t know when the market will fall or when it will recover. You don’t know the best time to get out of stocks and into bonds or vice versa. You don’t even know when it’s the ideal time to rebalance your portfolio, except in retrospect, of course.

So to deal with that lack of knowledge, you create a strategy, a disciplined system that can help guide you through the uncertainty.

I know that some people may see this as a head-in-the-sand approach especially given what’s been going on lately, what with major investment bank Bear Stearns getting snapped up at a fire-sale price, the Fed scrambling to keep the economy afloat and investors worldwide wondering what the next shock might be.

After all, in fast-moving and perilous times like these, don’t you have to be most nimble, most flexible, most willing to try something new?

Actually, no. It’s in times of crisis when you most need to stick to your plan. The far bigger danger in a volatile market like today’s is that you end up making a move that seems brilliant at the moment but turns out to be not so smart in the future.

Or, if you really get into the spirit of second-guessing your plan, maybe you end up making a series of such moves as you react differently to each crisis du jour.

That’s not to say you can’t ever deviate from your plan. If you find that you don’t have the stomach for risk you thought you had when you created your portfolio – it’s not unusual for investors to overestimate their appetite for volatility when the market is doing well – then maybe you need to scale back your stock holdings a bit. And if that’s the case, there’s no need to wait until you make your usual adjustment.

Similarly, if you’ve concluded after careful deliberation that some of your stocks or funds are clunkers that need to be replaced quickly, then replace them as soon as you find acceptable substitutes. You might even want to occasionally sell some holdings in taxable accounts to reap tax losses that can be used to offset other gains or even ordinary income.

But, remember, if you stray from your game plan too often and begin basing your rebalancing decisions on gut feelings about what the market may or may not do and when it might or might not do it, then you don’t really have a plan anymore. You’re just playing hunches.