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4 Steps to Protect Your Portfolio From the Financial Crisis

By Amanda Kish, CFA, CFP® - Updated Nov 11, 2016 at 3:42PM

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All is not lost, if you stay focused.

What a crazy couple of months, 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 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 that 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'd 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, choose only those with strong balance sheets, conservative lending standards, and some measure of transparency. Risk-takers Goldman Sachs (NYSE:GS) and Citigroup (NYSE:C) truly got themselves into trouble and face significant challenges ahead, but Bank of New York Mellon (NYSE:BK) and State Street (NYSE:STT), for instance, may in fact 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 that the U.S. could be entering a deflationary period. Last month, inflation dropped to an astonishingly low 1.1% from a high of 5.6% in July, signaling a significant overall softening in consumer prices and wages.

You might investigate companies that do well in deflationary times -- such as utility stocks. Consider giving FPL Group (NYSE:FPL), Entergy (NYSE:ETR), or American Electric Power (NYSE:AEP) 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.

This article was originally published on Sept. 19, 2008. It has been updated.

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. Click here to find out more about the Fool's disclosure policy.

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Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
C
$51.66 (0.78%) $0.40
The Goldman Sachs Group, Inc. Stock Quote
The Goldman Sachs Group, Inc.
GS
$334.67 (0.84%) $2.80
State Street Corporation Stock Quote
State Street Corporation
STT
$70.66 (0.47%) $0.33
Entergy Corporation Stock Quote
Entergy Corporation
ETR
$117.74 (-1.00%) $-1.19
American Electric Power Company, Inc. Stock Quote
American Electric Power Company, Inc.
AEP
$99.46 (-0.49%) $0.49
The Bank of New York Mellon Corporation Stock Quote
The Bank of New York Mellon Corporation
BK
$43.50 (1.02%) $0.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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