America’s increasing reliance on 401(k)s and other defined-contribution retirement accounts is something of a double-edged sword. On the one hand, because investors (not pension managers) decide how the funds are invested they have more control over the funds they’ll need during their later years.

But gone are the days when most investors can count on a predictable income stream from a defined-benefit pension once their career comes to an end. If the market takes a wrong turn at the wrong time, it could mean losing years of hard-earned savings.

When it comes to long-term investing, a degree of cautiousness can be a virtue. Those who plan for the next bear market before it arrives are in a better position to absorb the shock and maintain their current lifestyle.

Here’s what you can do now to protect your nest egg from the inevitable volatility of the market.

Maintain the Right Portfolio Mix

The single most important thing you can do to mitigate risk is to diversify your portfolio. Some investors believe having their savings in a mutual fund means they’re in good shape. Unfortunately, it’s not quite that simple.

There are two key types of diversification that every investor should employ. The first is asset allocation. That’s the amount of each asset class – whether it be stocks, bonds or “cash equivalents” like money market funds – you own.

As a general rule, you want to lessen your exposure to riskier holdings (e.g. small-cap stocks) as you get closer to retirement. These securities tend to be more volatile than high-grade bonds or money market funds, so they can put investors in a bigger hole when the economy goes south. Older adults, unlike younger workers, simply don’t have enough time to wait for a recovery when stocks take a hit. (See An Introduction To Small Cap Stocks. )

That’s why it’s important to work with a financial advisor and determine the asset allocation that best fits your age and investment objectives. Because asset categories will grow or decline at different rates over time, it’s a good idea to periodically rebalance your account to keep the allocation consistent.

Say you own a portfolio with 55% of the holdings in stock and 45% in bonds. Suppose that stocks had a great year and, because of these gains, they now comprise 60% of your account. Rebalancing means selling some of the stocks and buying enough bonds to maintain your overall risk profile.

The other type of diversification happens within each asset category. If 50% of your portfolio is dedicated to stocks, look for a nice balance between large- and small-cap stocks and between growth — and value -oriented funds. Most advisors suggest having some exposure to international funds as well, in part because it cushions the blow of a U.S. economic slump.

Keep in mind that not all bonds are created equal. For example, the debt of companies with a low credit rating – known as “junk bonds” – is more closely correlated to stock market performance than high-grade bonds. Therefore the latter are a better counterweight to the stocks in your account.

The goal is to have a proper mix of assets that historically don’t rise or fall at exactly the same time (see The Role Of Rebalancing) .

Have Some Cash on Hand

Those who are already retired have to maintain a delicate balancing act. To protect against outliving their assets, most financial planners suggest holding onto at least some stocks (see Is ‘100 Minus Your Age’ Outdated? ).

At the same time, retirees need to be more cautious about their investments because they don’t have the long time horizon that younger investors do. As a safeguard against economic slumps, some investment professionals suggest keeping up to five years’ worth of expenses in cash or cash equivalents, such as short-term bonds, certificates of deposit and Treasury bills.

If you’re worried that the rate of inflation will grow and eat away at your purchasing power, consider having some of your “cash equivalents” in the form of Treasury Inflation-Protected Securities. or TIPS. While the interest rate on these securities is fixed, the par value increases with the Consumer Price Index. So if the rate of inflation hits 4% annually, your investment grows right along with it.

Be Disciplined About Withdrawals

Simply put, the more money you have squirreled away, the better position you’ll be in should a bear market arise. This may sound simple, but too many retirees overspend in retirement, which leads to poor investment decisions that are made out of desperation.

The antidote: discipline in your spending habits. Most experts suggest withdrawing no more than 3% to 5% of your funds in year one of retirement in order to maintain a sustainable lifestyle. From there, you can adjust your annual withdrawal to keep pace with inflation. So if you determine that you can take out $2,000 a month in the first year and consumer prices rise 3% annually, your allotment would grow to $2,060 by year two. For details, see Strategies For Withdrawing Retirement Income .

By planning your withdrawal allowance, you eliminate the need to liquidate a large sum of assets at fire-sale prices simply to pay the bills.

Don’t Let Emotions Take Over

If there’s one tendency to avoid when saving for retirement, it’s impulsiveness. When stocks take a plunge, it’s tempting to try to cut your losses by selling shares. But most of the time, investors choose to act after the downturn is well underway.

You’re better off staying the course when things are rough. If you’re rebalancing your nest egg on a regular basis, that means you may actually buy more stock when the market’s down to keep your allocation in check. By purchasing at a low – or near the low – you’re poised to maximize profits when the market eventually rebounds.

It’s equally important to have a steady hand when the economy is humming along. If you’re still saving for retirement, resist the urge to cut back when your 401(k) is exceeding expectations. The market will always have ups as well as downs. Those who are ahead of expectations prior to a bear market will invariably have an easier time handling the fallout.

The Bottom Line

By its nature, the economy will always experience boom and bust cycles. Investors who take a disciplined approach and diversify their portfolio are almost always in a better position when the next bear market arises.