Seven Pillars of Asset Allocation Wisdom

"At the end of 1999, many investors said, 'What ... is this large value thing? Shoot the loser and buy more winners," Keefe said. "That was the wrong thing to do at exactly the wrong time -- many individuals gave up their chance to weather 2000 and beyond."

6. Rebalance

While 99% of individual investors don't benefit from active trading, they should rebalance their portfolio on occasion -- once a year is a fair option. As we noted recently, most investors never rebalance.

Rebalancing needn't be complicated. If you have a 70% stocks-30% bonds asset allocation, for example, you pare back a little bit of the asset class that has outperformed at the end of the year and add a little bit of the underperforming class to get you back to your 70-30 mix. This ensures that you don't get overexposed to one area -- just as failing to rebalancing in the 1990s meant the large-cap stock weighting in your portfolio got distended.

When rebalancing, investors need to reassess their situation. As you get a little closer to retirement, start shifting some of the stock portfolio into the relative safety of bonds and cash.

7. Know Yourself

A big determinant in an investor's asset allocation is age -- how close one is to retirement. They also need to factor life changes -- junior getting close to college age, etc. -- into their investment decisions. Likewise, there are other behavioral factors that come into play as well.

There are plenty of 30-somethings who went gray early watching their portfolios plunge the past few years. Reportedly asked once what the markets will do, J.P. Morgan replied, "Fluctuate, my boy, fluctuate." The markets have always been a bumpy ride. Investors need to make a clear-minded assessment about how much volatility and how many downturns they can handle.

"If you can't sleep at night, chances are you have too much risk," said Cynthia Meyers, a certified financial planner in Sacramento, Calif.

OK, now that we've discussed the tenets of asset allocation, please check out the companion story on how to use sector funds to improve your portfolio's diversity and overall returns.