4 Steps to Protect Your Portfolio From the Financial Crisis

What a crazy week, eh?

Right now, the United States is experiencing an unprecedented financial shake-up. No one knows just how deep, or far-reaching, the damage will be. Though to some extent we'll be at the mercy of the markets, here are four important steps you can take to protect yourself from a future financial fallout.

1. Don't make rash decisions
If I could give investors one piece of advice, it would be this -- turn off the TV! While government bailouts and plunging markets make for great headlines, they aren't the best trading indicators. It's perfectly reasonable to want to keep up with unfolding events, but making rash buying or selling decisions based on the latest updates from the media circus is a losing strategy.

As fellow Fool Tim Hanson recently pointed out, when you take a long-term view of investing, volatility isn't as much of a concern. If you're focused on the big picture, even harrowing market drops won't ruffle your feathers, because you know over the long-run the ups and downs tend to smooth out into a nice upward trajectory.

It's going to be especially hard in the coming months to stay focused and dispassionate, as the bad news is almost certainly far from over. This isn't to say you can't make adjustments to your portfolio in times like these -- just make sure you've got a solid, strategic reason for making changes, rather than selling and running away in fear.

2. Analyze your exposure to the financial sector
Whether you hold individual financial stocks, mutual funds, or ETFs, you may have more exposure than you think. If you own the S&P 500 index, for example, you are 15% invested in financial firms.

Even with the federal government stepping in with aid, banks and financial institutions are facing an uphill battle, so if you're holding a lot of financial stocks, you better be sure you understand how these companies make money and what the risks are in today's environment.

If you are going to invest in financial companies, only choose those with strong balance sheets, conservative lending standards, and some measure of transparency. Risk-takers Lehman Brothers (NYSE: LEH  ) and Fannie Mae (NYSE: FNM  ) truly got themselves into trouble, but BB&T (NYSE: BBT  ) and Wells Fargo (NYSE: WFC  ) , for instance, are more likely to emerge from this crisis in an even stronger competitive position.

3. Use market drops to look for new opportunities
As legendary investor Shelby Davis once said, "You make most of your money during a bear market. You just don't realize it at the time."

The bright side of a market sell-off is that intrepid investors can snap up some terrific stocks that have been dragged down with the rest of the market.

With the economy in a tailspin, declining housing prices, and tightening credit, there's a chance the U.S. could be entering a deflationary period. Inflation was down slightly this month (albeit to 5.4%), and this week the Fed, in light of declining energy prices, refused to cut rates any further.

You might investigate companies that do well in deflationary times -- such as utility stocks. Consider giving Dominion Resources (NYSE: D  ) , PG&E (NYSE: PCG  ) , or Southern Company (NYSE: SO  ) a second look. If such an environment does take hold, you'll be glad you did.

4. Make sure you've got a diversified portfolio
There are no clear answers on where we are going from here. But one of the best defenses against the financial crisis is a diversified portfolio.

That's one reason why I'm a fan of mutual funds, especially in today's challenging environment. Buying a handful of funds with top-notch managers means you're automatically diversified among dozens or hundreds of stocks. What's more, funds give you a little professional guidance in this uncertain market.

If you want the inside track on which funds are the best of the bunch, check out the Fool's Champion Funds investment service. You can sneak a peek at all of our picks with a free 30-day trial. Even if you're a die-hard stock picker, you might want to consider a fund or two to balance out your portfolio and add another layer of diversification.

Amanda Kish heads up the Fool's Champion Funds newsletter service. At the time of publication, she did not own any of the companies mentioned herein. BB&T and Southern Company are Income Investor picks. Click here to find out more about the Fool's disclosure policy.

Read/Post Comments (5) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 27, 2008, at 6:26 AM, mariammac wrote:


    So, how do you insure your portfolio. I've never heard of such a thing. As long as the insurance company doesn't go under, it might be a good idea.

  • Report this Comment On September 27, 2008, at 2:06 PM, marketimer1 wrote:

    The fallacy of the buy-and-hold strategy is coming home to roost.

    Buy-and-hold has enabled the entire mutual fund industry to grow and prosper, because you simply can't manage a portfolio if everyone is constantly jerking their money in and out. And it works ok if you have a 75 year plus time horizon. At least it has worked during an era when American industry was rising to a level of global dominance never before seen in history.

    And it has worked during an era of credit expansion which helped drive profit growth.

    But now we see other, better capitalized countries growing faster. Despite near-term commodity price volatility, resource depletion is very real and ongoing. Expansionist, commodity-centric economies are flexing their muscles for the first time in a generation. And we are on the precipice of a massive deleveraging phenomenon, which has already begun to impact growth.

    So I ask: If no one knows just how deep, or far-reaching, the damage will be, is the S&P 500 really worth 20X trailing 4Q numbers?

    In a word: No. By historic standards, the multiple should be in the single digits, and that's probably where it's going before this is over.

    In a nutshell, this market has far greater risk than any pundit will admit, and the only way to protect your portfolio is to be in cash.

  • Report this Comment On September 29, 2008, at 12:31 PM, EdistoFlounder wrote:

    For years various brokers have advised "just ride it out". Most famously was Cisco @ +100. As it went down, I was advised to cost average. Hum, so much for that thought. Several months ago, I asked, How will you preserve my capital? Again, "just ride it out." "Look at the long term"

    Is this the only mantra from brokers? I've work with many over the years but they all seem to be one trick ponies.

    When I was 30, hold for the long term was OK. Now at 60, that doesn't work so well. Is there any thinking outside of the box?

  • Report this Comment On September 29, 2008, at 5:29 PM, TerryHogan wrote:

    I wouldn't necessarily call it 'outside the box' but I'm getting into some DRIPs for solid companies. Anything with a 4% or greater yield that you think is going to be around for a while. A 4% yield will get you a new share every quarter if you buy 100 shares. I guess at 60 you might have a different time horizon though. Tough to say for you. I personally look at stocks as investments for a 10 year minimum time horizon. You might want to look at some preferred shares in solid companies that have taken a beating, you can lock in a decent yield (easily 6%) with quite a bit of upside potential. I like the preferreds of the Canadian banks right now, though there might be currency risk depending on where you reside. If you plan on living to 80, I'd say now is the time to buy!

  • Report this Comment On October 02, 2008, at 10:41 AM, chrisjrogers wrote:

    Deflation? I don't think so. Not with the US government wanting to print $700 billion out of thin air.

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