By Dawn Bennett, CEO, Bennett Group Financial Services

It is hard not to feel a twinge of fear about your investment portfolio following the poor performance of the major stock indices going into 2008.

Year to date (through November 19, 2007), the Dow Jones Industrial Average has provided a paltry 3.97 percent return, including reinvested dividends, and the Standard & Poor's 500 was not far behind at 2.72 percent.

In the beginning of 2007, the tendency was to expect the trends of 2006 to continue indefinitely. But, when the news is mostly negative, as it has been lately, it should be a wake up call wrestling you back to reality. The number of "reality checks" has been growing daily to the point where they are near impossible to ignore. In fact, they lead me to believe that 2008 might be a difficult year.

While investors should always be wary of what's around the corner and position their portfolios accordingly, it is now particularly important to be cautious and to refrain from throwing caution to the wind.

Bubbles, Bubbles, Terrorist Troubles

Why do I believe caution is in order? The slowdown in home sales and new-home construction is a big concern because it has been such a huge engine of growth in the past few years.

Our gross domestic product is below the long-term trend, expected to grow at a dismal 0.70 percent annual rate in the first quarter of 2008 and at 2 percent or less for the full year next year.

All of this plays out against a backdrop of increasing geopolitical uncertainty. The Middle East grows more complicated every day. North Korea, Venezuela, and Pakistan continue to be areas of great concern. Russia has shown signs of a desire to reconstitute the authoritarian ways of the Soviet Union.

We are likely to see a continued flight to safety going into the end of 2007. One of the best ways to defensively position yourself is by spreading your investments among many asset classes: Investors should own around a dozen of them. This method of portfolio allocation allows investors to place their money into assets that are less volatile than the average therefore creating a defensive posture.

Ideally, a defensive investor should have a portfolio of securities that generate a healthy amount of income from interest and dividends as well as appreciate in price. Stock indices will not always post double-digit gains as they did in 2006 and the first half of 2007. In fact, we could be in for a long period of below-average returns. If that's the case, the income portion of your portfolio will take on greater importance.

Among stocks, a well-diversified portfolio should include large-, mid-, small - and micro-capitalization companies. Investors should avoid overweighting or underweighting specific stock sectors, such as utilities or technology companies.

Long-Term Investors: Prepare for Mental Games

Every sector is cyclical to some degree. If you are a long-term investor, some mental games are required. Your asset classes will all go through ups and downs, and that is normal. Be prepared so you don't panic. The key is to own enough asset classes so that those in the up cycle will more than offset those that are in the down cycle.

Within fixed-income instruments, you should allocate money to short- and medium-term government bonds (with maturities of seven to 10 years) and municipals.

Corporate bonds, because their performance is tied to corporate earnings, might not perform as well as Treasuries and government-backed bonds in an economic slowdown.

Thanks to the foreign demand that showed up in 2006, the performance of Treasuries should be steadier this year. Municipals are appropriate only for taxable accounts, not for 401(k) and other types of tax-deferred accounts. You should also avoid municipals whose tax-free coupon payments are subject to the Alternative Minimum Tax (AMT) or, at the end of the day, Uncle Sam just might walk home with more than you. Conversely, don't turn your head when an historically well managed, insured, tax-free municipal, non-AMT bond fund is available for your portfolio. This might be a situation in which Uncle Sam gives more than he takes.

Also essential is a healthy international component, divided evenly between stocks and bonds. Investors should prepare to capitalize on the rise of emerging-market countries such as India and China. These economies are poised for many years of growth and middle-class development, much in the same way as the U.S. was in the 1950s and 60s. Don't forget, though, an investor benefits from a long-term perspective for the potential positive results.

Certain types of hybrid assets, such as preferred stock and convertible bonds prove attractive as well. They are called hybrid because preferred stocks have some bond-like characteristics (a regular cash payment and some protection in bankruptcy), and convertible bonds have some stock-like characteristics because they can be exchanged under certain conditions for shares of stock.

In the final analysis, owning many asset classes provides strong and consistent returns over time. There is no doubt that a portion of such a portfolio will lag at any given point, but it is unlikely your losses will ever be crippling. And remember, a good defense is the best offense.