Our previous post discussed the fact that the high reached by the Dow Jones Industrial Average on Friday, August 21st may motivate some people to invest more in large U.S. stocks when they actually should take a pause and rebalance their portfolio (see our post titled: “Time for a Portfolio Rebalance?”).

But what if you panicked last year and pulled everything out of the market? Should you get back in now? Or is it too late? You clearly need to get back in sometime soon, if you want to keep up with future inflation.

Before you do, however, you need to take a new look at your risk tolerance. You need to determine the proper mix of stocks and bonds that will allow you to stay in the market regardless of what is going on. That way you won’t miss the market rebounds when they come (It’s very tough to time the market!).

How to decide what level of risk is right for you can be difficult. In our opinion, rules of thumb based on your age don’t typically jive with one’s emotional makeup. Often, risk questionnaires lead to an incorrect assessment of your personal ability to tolerate risk. We show our clients target portfolios along with statistically generated ranges of returns (based on historical data) that those portfolios may receive going forward. This helps clients visualize the gains and losses a given target portfolio might achieve in the future. However you determine your risk tolerance, we suggest you seek the help of a professional advisor. This step deserves significant thought before diving into the market.

Once you’ve determined the appropriate level of risk, we suggest you reinvest utilizing a dollar-cost-averaging (DCA) approach. Although we’ve seen studies that conclude it really doesn’t make much difference if you reinvest everything at once or utilize a DCA approach, we believe the DCA method works better from a psychological standpoint.

A recent Wall Street Journal article titled “The Mistakes We Make – And Why We Make Them”, August 24, 2009, states that “Dollar-cost averaging is not rational, but it is pretty smart.” Generally speaking, if you dollar-cost average you’ll feel good no matter what the market does. If the market goes down, you feel good that you still have money on the sidelines. If the market goes up, you feel good that you invested some of your portfolio.

So, if you pulled everything out of the market because you couldn’t handle the stress of the crash, dollar-cost averaging can provide a way for you to get back in that makes you feel good no matter what the market does. Lastly, it is extremely important to know exactly how to allocate your money when you go back in; it will help take the emotion out of investing.