These are testing times for investors. Hardly a day goes by without dire headlines about some new threat to the health of the global economy or the financial system. Last year's all-time highs for many equity markets seem a distant memory, as the declines which started in the summer of 2007 continue.

The reason? Financial markets have been faced with recurrent concerns over the well-being of banks and other financial institutions as the credit crunch unfolds, alongside worries about the potential spill-over into the economy. A raft of poor news flow in recent weeks has cemented the belief that the fallout from the US-spawned credit crisis is spreading beyond American shores more quickly than initially predicted – with the UK ending a 15-year run of economic expansion in the second quarter as GDP proved flat. Rising commodity prices for much of this year and consequent inflationary pressures have added to the problems, as central bankers have been reluctant to cut interest rates to promote growth as prices continue to rise.

These concerns about the global economy have made equity markets much more volatile. In 2005, the FTSE 100 Index didn't fall by 2% or more on any single day. This year, it has already fallen that far on 17 days. This climate of concern increases the risk that investors' decisions will be driven by emotion.

"Asset allocation can be broken down into two types: strategic (or long-term); and tactical (short-term)."

Yet, at times like these, it's more important than ever to stay calm and maintain a rational perspective. Focus on your long-term goals and what you can do now to help you achieve them. One of the keys is having the right asset allocation – that is, making sure you have your portfolio invested in the most appropriate mix of assets.

Asset allocation can be broken down into two types: strategic (or long-term); and tactical (short-term). The strategic allocation is designed to choose the blend of assets that is most likely to achieve your investment objectives over the long term. The tactical allocation aims to take advantage of any short-term opportunities in markets and to help protect your portfolio against any immediate risks.

The cornerstone of strategic asset allocation is spreading your investments across different types of assets, to create a well-diversified portfolio. That reduces the risk if any one asset suffers poor performance. For example, over the past 12 months, equities have fallen significantly in many markets, but up until recently holding commodities could have helped to protect against those falls, as commodity prices rose significantly earlier this year.

However, it's not enough to pick a long-term asset allocation; you also have to stick with it. As many investors are painfully aware at present, it can be hard to accept losses even in the short term. But investors who lose their nerve during market downturns risk buying at the top and selling at the bottom, thus turning paper losses into real ones. So it's important for investors to choose a strategy they will feel comfortable with throughout the lifetime of their investment.

Unfortunately for risk-averse investors, picking lower-risk investments such as bonds doesn't provide the whole answer. Holding bonds tends to increase your income, but it can lose money over the long term, as inflation erodes the value of the investment. And it's worth bearing in mind that, because of their type of expenditure, the real rate of inflation for high-net-worth individuals in recent years has tended to be much higher than the official measures, which in recent years have been kept low by the falling prices of cheap manufactured goods and electronics. Besides, the recent behaviour of bond markets shows that, even though they tend to be less volatile than equities, bonds are not risk-free and can still suffer periods of significant declines.

"As many investors are painfully aware at present, it can be hard to accept losses even in the short term. But investors who lose their nerve during market downturns risk buying at the top and selling at the bottom."

So strategic asset allocation should ensure that a well-diversified portfolio contains not just a spread of equities and bonds but also other assets such as commodities, hedge funds and property, which can help to spread the risk and thus achieve a higher potential return for a given level of risk.

Within that strategic framework, tactical asset allocation allows us to increase exposure to the assets we expect to do well in the near term and reduce exposure to those believed will under perform. Take the past year as an example. With inflation rising but economic growth slowing, we increased holdings of assets such as commodities and inflation-linked bonds, which subsequently performed well.

So where do Coutts see opportunities at the moment? Unfortunately, the near-term outlook remains abnormally uncertain, and Coutts expect further volatility in most markets. But this climate of anxiety has created opportunities for longer-term investors. In particular, we believe inflation concerns within developed markets have been exaggerated. The economic slowdown should help inflation pressures to dissipate. We expect inflation to peak and then abate in the wake of food and energy price falls, which should allow for cuts in interest rates to stimulate the economies of the UK and Europe.

Partly as a result of these inflation concerns, equity markets have fallen to levels where they appear cheap relative both to their own past valuations and to bonds. And valuation is the best indicator of long-term returns. In fact, our analysis suggests that, over the next five years, equities are likely to generate good returns and comfortably outperform cash. As the graph above shows, Coutts forecasts (based on previous similar episodes) suggest that global equities should deliver total returns of roughly over 50% over the next five years. And there’s a probability of around two-thirds that returns will be somewhere between 12% and 110% - which may offer some comfort right now.

So, although the immediate outlook remains gloomy, we see some interesting opportunities emerging for long-term investors, particularly in equity markets.