+1 for balanced asset allocation. Of liquid assets, stocks have the highest potential for long-term growth, but if you're scared, allocate only a small portion of your assets to them: Put the rest into a mix of bonds, cash, and cash equivalents (money markets, CDs, treasuries, TIPS, etc.). Add a smaller REIT slice if you want a dash of risk but potentially higher dividends. With some exceptions (the 2008 crisis being one: everything tanked then), bonds tend to do fairly well during bear markets because spooked investors that pull out of equities pour funds into "safer" assets (fixed income). That drives prices up and preserves some of your capital.
As others have said here, you have to look at yourself in the mirror and understand how much risk you can actually take (How much income will you really need in retirement? Can you adjust your lifestyle during prolonged bears?) and how much you can stomach (How well do you want to sleep?). You're in or nearing the "wealth preservation" stage of your life and sound like you're risk-averse, so you'll probably want to play it safe and allocate more to income-generating assets like bonds. Some people only invest in bonds and bond equivalents (REITs) and live on the interest/dividends; I'd prefer to leave some assets in stocks even in this market because even if they tank tomorrow, they will probably rebound and grow in the (very) long run. They'll pay dividends in the meantime. But that's just me: You have to figure out what you need for yourself.
Here's a wonderful quotation from the final chapter of Burton Malkiel's "A Random Walk Down Wall Street" (the latest edition), a book I highly recommend:
The first decade of the new millenium was one of the most challenging times for investors. Even a broadly diversified Total Stock Market fund devoted solely to U.S. stocks lost money. But even in this horrible decade, following the timeless lessons I have espoused [namely, picking a balanced asset allocation and sticking to it] would have produced satisfactory results. [...] An investment in the VTSMX (the Vanguard Total Stock Market Fund) did not produce positive returns in the “lost” decade of the “naughties.” But suppose an investor diversified her portfolio with the approximate conservative percentages I suggested [...] for the “aging baby boomers.” The diversified portfolio (annually rebalanced) produced a quite satisfactory return even during one of the worst decades investors have ever experienced.
“Satisfactory” is an understatement. He displays a graph showing that the balanced portfolio nearly doubled over the decade. Sure, it dipped during the two plunges, but it did well overall.
The portfolio is 33% fixed income (VBMFX), 27% U.S. stock (VTSMX), 14% developed foreign markets (VDMIX), 14% emerging market stocks (VEIEX), and 12% REITs (VGSIX).
Knowing how much you'll need in retirement (capacity for risk) and how well you need to sleep during bear markets (tolerance for risk) is key. Then you can pick an asset balance you're comfortable with and stick to it. And try to live flexibly if you can: When the markets tank (and they will, it's inevitable), being able to cut back even a little greatly increases your odds of weathering the storm until good times return.
You're in an enviable position. Congratulations on making it!
