Is Your Portfolio Prepared for Disaster?

Volatility has returned the last couple of weeks into the markets, including stock, bond and currency markets.  Several issues that have been simmering finally surfaced and a couple of relatively unanticipated news items as well.  For example in the last few weeks, we’ve seen Greece pushed to the brink of bankruptcy and back (several times). We’ve seen the market react over the possiblity that contagion might spread to Spain and Portugal, and European stocks and the Euro have underperformed sharply. Recent news of an SEC investigation of Goldman Sachs has hammered the financial industry. And then last week, the news of the spreading oil spill in the Gulf of Mexico caused oil stocks, which had outperformed to date.  From an investment portfolio standpoint, the events of the past couple of weeks hilight some important investment strategies that should be considered for overall risk management:

–Don’t panic in the face of bad news — the most common thing that I hear from people regarding the substantial runup in the market in the last 13 months is that they feel they missed out, but staying too much in cash or shifting their portfolio to bonds after the market rout of 2008-early 2009.  If you tend to be prone to panic, the best choice is usually to automate your savings (like an automatic monthly 401K investment arranged through your plan sponsor).

–Be sure that you have real diversification — Most assets are correlated in some way or another with each other.  However, the problem with most portfolios is that many people feel that simply having two different assets provides enough diversification. Unfortunately, this isn’t always the case. For example, many countries in Europe have suffered with the crisis in Greece with credit quality spreads widening sharply and stock markets down.  In addition, many financial stocks have declined over systemic concerns of greater regulation and fees. Simply holding more than one in each of these categories would not have offered real diversification.

–Be aware that any company can suffer an unforeseen event — in the case of picking individual stocks, no matter how much due diligence you do, something unexpected may happen. Again diversification is key to ensuring your portfolio is not hit too hard. This is particularly true if you receive your retirement match in company stock.

–Be prepared to re-allocate your portfolio if the markets move substantially — staying on top of target allocations often pays off in the long run.

shared at this week’s Carnival of Personal Finance