Investors are scared. The value of their portfolios has plummeted. Now many are seeking safety instead of returns.

If you are one of those investors, you need to understand the different levels of security in the options available to protect you.

But first, ask whether capital preservation is really the right goal for you.

If you anticipate needing 20% or more of your assets within a five year period, you should not have any exposure to the stock market. You need the confidence of knowing your money will be there when you need it. You cannot afford the kind of market volatility we are experiencing that could cause you to sell at a loss to pay living expenses.

You have a number of choices outside the stock market. As with all investments, you are rewarded for taking risk. Remember: The most secure choices will pay the lowest interest.

The liquidity crunch is having unprecedented ramifications in markets that were traditionally regarded as very safe. Many financial experts now regard only cash and debt secured by the full faith and credit of the U.S. government as really safe.

This post is part of a series where personal finance expert Dan Solin looks at money moves that may seem smart in tough economic times, but are actually quite dumb. See all 12.

Almost everyone has taken a big hit in this bear market. Many investors are tempted to take more risk with their portfolios to make up for their losses.

This is a bad idea.

Your asset allocation, the division of your portfolio between stocks and bonds, accounts for as much as 100% of the level of your returns, according to one prominent study.

Your asset allocation is determined by your ability to withstand market volatility. In large part, it is determined by the amount of time you can keep your assets invested without withdrawing a substantial portion (20% or more) of them.

The fact that you may have lost money in the current markets does not mean that you are able to take more risk. In fact, it may mean the opposite: Your ability to withstand market losses has diminished.

Remember that "risk" means "volatility." When you take on more risk, you are increasing volatility. Volatility is a two way street. It moves both up and down.

If you're like most people, you probably have a larger percentage of your investment money in cash than you had two years ago. While some investors are taking their chances in this recent market volatility, many are choosing to wait on the sidelines until the "All Clear!" call comes in (whenever and however that's really communicated -- but that's another blog post).

Well, these investors sitting on cash are not alone. Bloomberg reports this morning that mutual funds have been desperately selling stocks and moving to pretty sizable cash hordes. In a survey conducted by Merrill Lynch and reported by Bloomberg, managers have been feverishly adding to their cash positions and consequently, "cash relative to total assets also rose to a five-year high as managers found fewer stocks to purchase and anticipated redemptions."

This brings up a couple of issues. Let's be clear: mutual fund managers want to manage volatility like all investors. The problem here is that if I hand my money over to a small cap manager because I believe he's pretty proficient in picking stocks, I don't really want him moving into cash. That's my job as portfolio manager of my own investment account. I'm essentially paying him to be in the market -- not move out of it.

Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.
--Warren Buffett

Here's an interesting blog post on SeekingAlpha written by Larry Swedroe. Swedroe, Director of Research of BAM Advisor Services, focuses on results stemming from the last 11 recessions. Returns during these periods averaged out to 7%, a full 2% more than what Treasuries averaged during the same periods.

This means, even if investors could perfectly time selling their portfolios of stock at the market high, they still would have made out worse than holding through the recessionary periods.

Unfortunately, even most professional investors can't forsee market tops. What ends up occurring during tumultuous times like these is that investors overtrade and the market truly becomes Buffett's "relocation center from the active to the patient."

Despite the big run in domestic equity prices for 2007, investors are still conservative.

In a note sent to clients yesterday, Tom McManus, chief investment strategist of Bank of America, points out that investment in open-end mutual funds increased a measly +$1.2B, slightly better than the +$1.0B figure for the prior week. Total growth in equity fund assets was just 1.9% year over year. This is hardly a sign of stock market euphoria.

While in taxable bond funds, growth was 9.9%, with total corporate bond investment jumping 12.2% and investment grade bond investment jumping 18.1%.

As the baby boomers get older, it should be expected that investors will allocate more of their assets into more conservative instruments. However, this is very conservative and a sign this bull market has a long way to go.

Stay with stocks and avoid bonds is still the investment theme until there is a serious sentiment change in favor of stocks.