It's time to panic.

Okay, now that we've got your attention, let's be clear: We're exaggerating - at least a little. We don't think the financial system is on the verge of collapse. But the complacency exhibited by many market pundits in the wake of the most wrenching episode in modern financial history is sufficiently shocking that it almost demands some scare-tactic response.

By our count some 300 articles were published last month telling investors "don't panic" or "not to panic." Urging calm is one thing. But too much soothing talk implies that there are no lessons to be learned. What's the use of a vertigo-inducing bout of market turbulence if the only conclusion is "stay the course"?

At the very least, it's a good reminder to take a hard look at your financial plans and to reevaluate how much market risk you can truly withstand in your portfolio. Because - don't panic! - this might not be completely over.

Richard Bernstein, the chief investment strategist at Merrill Lynch, worries that investors still don't appreciate the scope of the credit crisis.

"It's weird - the canary in the mineshaft has fallen over, and now everyone thinks there's a problem with canaries," says Bernstein, who, despite sounding the alarm about a global credit bubble as far back as 2006, could find himself out of a job after Merrill's forced sale to Bank of America. (Too bad Bernstein's Merrill bosses didn't heed his warnings.)

In Bernstein's eyes, the canary is the U.S. mortgage market, but the silent killer of loose credit was an international epidemic. "I don't perceive that most investors fully appreciate either the depth of the credit bubble or how broad-reaching it was in terms of emerging markets and hedge funds and commodities and all these other inflated asset classes that were dependent on easy credit," he says.

If consumers suddenly can't refinance their mortgages and credit cards and if more corporations can't issue bonds or tap lines of bank credit, their ability to weather any slowdown will be diminished. "The fundamentals are still extremely scary," says star financial-sector analyst (and recent Fortune cover subject) Meredith Whitney of Oppenheimer & Co. "It all gets down to how much liquidity will be created for consumers and corporations, and at the moment there's still less and less by the hour."

Here's another reason to be concerned: The professionals managing your money haven't gotten this market right. Consider that at the market low on Sept. 17, only five diversified U.S. equity mutual funds - out of a universe of 9,100 - had positive total returns for the year, according to Morningstar. FIVE! Even after the market rebounded, there were still only three funds with returns this year of 10% or better: Parnassus Small-Cap, Heartland Value Plus, and Forester Value.

If you haven't heard of any of those funds, that's the point. The investing world's best and brightest appear to be just as confused as the rest of us. Like Bill Miller. His streak of beating the S&P 500 now a distant memory, the Legg Mason Value Trust manager is down 35% this year. CGM Focus's Ken Heebner, whom Fortune dubbed "America's hottest investor" in June, is down 16%, while FPA Capital's Bob Rodriguez ("the best fund manager of our time," according to our sister magazine Money) is down 3%.

So how did the three 10%-plus returners beat the odds? One common thread is that they all stayed away from bank stocks. Beyond that, each went his own way. Thomas Forester, who runs his eponymous $20 million fund out of his study in suburban Chicago, made a successful bet on consumer staples - names like Anheuser-Busch, J.C. Penney, and Wal-Mart. Brad Evans, manager of Heartland Value Plus, got into and out of oil stocks at the right times.

And Jerome Dodson, the 65-year-old manager of Parnassus Small-Cap, was king of the contrarians, earning his double-digit returns with an assist from the unlikeliest of sectors: homebuilders.

"Every one of my analysts said, 'Don't do it,'" Dodson says of his early-year decision to buy the builders. But Dodson was convinced that the companies' stocks would bounce back long before their plummeting earnings did. He wound up taking sizable positions in Pulte Homes and Toll Brothers, which are up 40% and 17%, respectively this year. Dodson himself admits he got a little lucky.

You can't count on hitting that kind of jackpot. But by taking a hard look at your portfolio, you can minimize your losses and prepare yourself to take advantage of new opportunities. And this is one time when following simple financial-planning tips could be worth more to your bottom line than picking the right stocks or funds. So let's start with some strategy before we get to our specific investment recommendations.

Take some tax losses. If you buy and sell stocks in a taxable portfolio, it's likely that you have some holdings trading for well below what you originally paid. Our advice: Sell your losers pronto and book the capital losses.

Those losses can be carried forward from one tax year to the next (and the next and the next) and thus used to offset future capital gains whenever the market rebounds. Not only that, but Boston accountant Gale Raphael of Raphael & Raphael points out that taxpayers can deduct up to $3,000 in capital losses from ordinary income. That amounts to a tax savings of $990 a year to someone in the 33% tax bracket.

What if you think your losers are about to rebound? IRS rules prevent you from buying them back for 30 days. But if you can't wait, try using the proceeds from your tax-loss sale to purchase stocks similar to the ones you're selling.

If you take a loss on United States Steel, for instance, replace it with rival steelmaker Nucor. John Maloney, who manages high-net-worth accounts with M&R Capital in New York, says the IRS rules even allow you to take a tax loss on, say, Schlumberger, and replace it right away with an oil-services exchange-traded fund in which Schlumberger is a major holding. Says Maloney: "It won't trigger an objection unless it's materially the same security."

Rebalance regularly. We called Charles Schwab & Co. investment strategist Liz Ann Sonders looking for some stock-sector suggestions, but all she really wanted to do was preach the gospel of portfolio rebalancing. Sounds dull, we know, but the more we listened, the more we appreciated the timeliness of her advice.

"It's 'Take your vitamins and eat your vegetables,' but it's really the most powerful tool that investors don't use that they ought to," says Sonders.

Sonders considers the 2008 bear market a "wake-up call" for investors who until now have given short shrift to asset allocation and have avoided thinking hard about their appetite for risk. "For example, if you have absolutely no tolerance for a bear-market-type decline" - i.e., a 20% or more move downward - "then you certainly shouldn't have all your money in stocks."

The great advantage to robotically rebalancing your portfolio once a year is that it takes a lot of the guesswork out of investing. "It lets your portfolio tell you when it's time to do something," says Sonders. "It doesn't put you in the position to have to figure out which economist or which strategist is going to be right when he or she says, 'Get out of emerging markets now' or 'Time to buy financials now.'"

Think about it this way. Investors who decided to put 10% of their portfolio in emerging markets five years ago made out like bandits during the multiyear market boom through the end of 2007 in India, China, and other rapid-growth economies. But if they didn't rebalance, by the end of those five years that 10% allocation had ballooned into a much bigger investment, and one fraught with risk. That was especially painful this year, because the Chinese and Indian stock markets fell even further than the U.S. indexes, down 60% and 30%, respectively. A regular rebalancer, by contrast, has taken profits along the way and can now buy back in at a lower price.

Move into munis. If the puny yields on Treasury bonds are getting you down, consider shifting your fixed-income allocation into municipal bonds. Interest income on muni bonds is exempt from federal income taxes (and most state income taxes too, depending on the bond and where you live), which is why the yields on AA- and AAA-rated municipal bonds are usually a quarter of a percentage point lower than for comparable Treasury bonds.

Not so right now. Keen demand for Treasuries from safe-haven-seeking investors is creating an anomaly: The average yield for ten-year AAA-rated munis now stands at 3.96%, vs. 3.80% for ten-year Treasuries, according to Bloomberg. For someone in the 33% tax bracket living in New York, California, or some other place with a high state income tax, that's the equivalent of getting a yield of about 6.50% on a taxable bond.

If you prefer tax-exempt bond funds to individual bonds, a good option is American Century Tax-Free Bond (TWTIX), an intermediate-maturity fund with a 3.91% yield and a history of steady returns.

Don't lose faith in stocks. By the numbers, there's a case to be made that stocks are historically cheap. But to us, that's more of an argument not to abandon stocks than to go all in. Our advice: Stick with a basic asset allocation: 60% stocks, 30% bonds, and 10% cash. (Obviously you'll need to fine-tune this, depending on age. A 25-year-old should have a much bigger stake in stocks than a 62-year-old, whose top priority should be wealth preservation.)

In any case, the argument for buying stocks is a strong one. With a price/earnings ratio for the past 12 months of 15 and a dividend yield of 2.3%, the S&P 500 is the cheapest it's been in ten years. Indeed, equities look far more enticing than Treasury bonds. The stock market is generally considered to be fairly valued when the earnings yield of the S&P (the inverse of P/E) is on par with the yield on ten-year Treasury bonds. Based on today's yields, stocks look grossly undervalued: The earnings yield of the S&P 500 stands at 6.5%, vs. 3.8% for ten-year Treasuries.

History also offers encouragement for buyers. According to a study prepared by Murray Leith, research director for Canadian investment house Odlum Brown, buying stocks at times of doom and gloom usually pays off. Over the past 40 years there have been eight bear markets in the U.S. In the first full year after the official declaration of a bear market, the S&P 500 returned an average of 12%, better than the 7.5% annualized return over the full 40 years in Leith's study. One disquieting note: The last bear market was an exception. Had you invested in an S&P 500 fund in 2001, you would have lost 22% after two years.

Be extremely picky. For your core holdings, stay away from bank stocks entirely. Yes, there's a chance that beaten-down bank stocks will rebound now that the federal government wants to help them get bad loans off their books. But we think there's just too much uncertainty about what the final bailout bill coming out of Congress will look like.

For similar reasons, we're loath to recommend any nonfinancial company whose business depends on access to bank credit or capital markets. Cash really is king today, and those companies that are cash-rich are going to be in a strong position to pick off some of their overleveraged rivals. Berkshire Hathaway's recent acquisition of cash-strapped gas and electricity supplier Constellation Energy is a case in point.

For a list of cash-rich companies with good prospects, we used Baseline's stock-screening tool to search for companies with low debt (debt-to-capital ratios of 10% or less) as well as modest valuations (price/earnings ratios of 14 or less) and solid earnings forecasts (earnings-per-share growth of 10% or better for both 2008 and 2009).

We required that they be dividend-paying companies, because those generally outperform the market and have done so significantly over the past three months, when the average dividend-paying stock had a total return of -3.9%, vs. -7.9% for companies not paying dividends. Among stocks with market capitalizations of $1 billion or more, 12 stocks passed the screen and three in particular stand out as good buys.

The first is tech behemoth Microsoft (MSFT), which happens to be a current favorite of fund manager Forester. Despite some recent stumbles, Forester sees plenty of upside for the software giant. "My gosh, at 13 times earnings, whatever problems they have seem to be fully priced into the stock," he says. Another reason to buy now: On Sept. 23, Microsoft announced a five-year, $40 billion stock-buyback program and raised its quarterly dividend.

We also like a pair of stocks from the oil patch. Diamond Offshore Drilling (DO) and Noble Corp. (NE) are both offshore drillers - expensive contractors that a Shell or Chevron will hire to drill for oil and gas in deep water.

Their stocks are down 20% and 16%, respectively, this year, reflecting the market's perhaps dubious assumption that oil prices will collapse along with the global economy. The two stocks barely budged on Sept. 22, a day when oil prices rose over $16 a barrel, to $120 - the biggest one-day jump ever. They're both reasonably priced, with P/Es of 14 for Diamond and nine for Noble. And 2009 earnings at the companies are expected to grow 23% and 26%, respectively. Those are the kind of value plays that look attractive in any market.