The effective failure of Bradford & Bingley is a stark reminder that these remain unprecedented times for stock market investors. The number one priority now is to protect your portfolio from losses. Here’s how...
What a mad week we had last week. This week doesn’t appear as if it will be much different, starting with the news of the effective failure of buy-to-let mortgage ‘specialist’ Bradford & Bingley (LSE: BB.).
It’s the third UK bank to effectively fail, following in the footsteps of Northern Rock and HBOS (LSE: HBOS).
Despite our own problems here in the UK, the epicentre of the credit-crisis remains firmly in the United States of America. Right now, the US 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.
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. Analyse your exposure to the financial sector
Whether you hold individual financial stocks, unit trusts, or exchange traded funds (ETFs), you may have more exposure than you think. If you own the FTSE 100 index, for example, you are already heavily invested in financial firms. The same almost certainly goes for your pension fund.
Even with the US federal government stepping in with their bail-out plan, 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 Bradford & Bingley and Northern Rock truly got themselves into trouble, but Lloyds TSB (LSE: LLOY) and HSBC Holdings (LSE: HSBA), 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. and UK could be entering a deflationary period.
You might investigate companies that do well in deflationary times -- such as defensive stocks. But as ever, beware of high debt levels. Consider giving large, stable companies like Tesco (LSE: TSCO), Diageo (LSE: DGE), Unilever (LSE: ULVR) and British American Tobacco (LSE: BATS) a look.
If such a deflationary 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 defences against the financial crisis is a diversified portfolio.
As I mentioned above, anyone who has had a large exposure to the financial and property sectors, for example, will have seen their portfolio hit hard times. The commodities sector has had a good run over the past few years, but has recently come under pressure as the oil price has faltered and other energy and metals prices have fallen from their recent highs.
One way to quickly and easily diversify your portfolio is by investing in an index tracking fund. You’ll instantly get exposure to the banking, drug, telecoms, oil and gas, tobacco and mining sectors, and that’s just from the top 10 companies in the FTSE 100 index.
These remain tricky and uncertain times. Opportunities are out there, but just as there are opportunities, there are also pitfalls. This is not a time to panic sell. It’s a time to rationally sit down and review your portfolio, protecting it from losses, yet positioning it to benefit from the inevitable market upturn, when it eventually comes.
Hang in there.
> See what thousands of other fellow investors are saying about the credit crisis by checking out the Motley Fool’s vibrant discussion boards. Click here to go to the very popular Banking Sector discussion board.
> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in HBOS. It’s only a small beneficial interest now, as he was far too slow to react to the reality of the credit crisis. Happy investing.
> This article was first published on our sister site, Fool.com. It has been updated.
