6 Ways to Insulate Your Portfolio from Shocks

Financial experts suggest these strategies for weathering the financial storm.

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With stocks bouncing around more than a San Francisco street car, many investors are looking for ways to ground their portfolios. Stability is not easy to find in this market, but financial experts recommend these six moves to anyone hoping to insulate their portfolios from major bumps:

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Focus on staples. People buy household products and spend money on healthcare regardless of how much they're hurting financially. That's why companies such as Procter & Gamble, Kellogg, General Mills, and Johnson & Johnson are thought to be somewhat recession-proof. In general, larger companies with more diverse product lines also tend to be more insulated from market swings. In the recessionary year 1990, for example, the Russell 2000 index, which is composed of small-cap stocks, lost 20 percent, while the S&P 500 lost only 3 percent.

On the other hand, companies that produce discretionary items, such as Ford or GM, tend to be more vulnerable. For the most part, though, big companies are still affected by the market's moves—both up and down.

Shift into bonds. Money-market funds and short-duration bonds tend to do well when stocks are losing value, although low interest rates across the board also translate into lower bond yields. That makes bonds a good bet for people who prioritize safety above returns. But that can also mean losing money after taking inflation into account.

Take home cash. Savings accounts are among the most insulated places to store money, but like money market funds, they can lose out to inflation. Still, financial experts often suggest keeping at least three to six months' worth of expenses in a savings account that is FDIC-insured and fully protected from any risk.

Divide your portfolio into tiers. In The Ten Truths of Wealth Creation, John Girouard suggests dividing your money into three groups, depending on how soon you need it. The size of each one will vary by person, depending on financial goals and age. The first group should be in investments protected from market instability, such as money market funds and savings accounts, which currently play close to a zero percent interest rate. That money is available for immediate spending.

The second, which contains money you plan to use after five years, should be divided relatively evenly into stocks and bonds. And the third, which you plan to use after 10 years, should consist mostly of stocks. "You've got to layer your investment portfolio," he says, to make sure the money you need tomorrow isn't threatened by market cycles.

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Use target-date funds. Investors who struggle to keep their portfolios updated as they age can use target-date funds, which automatically shift to more conservative investments over time. They are most popular for retirement funds and college savings funds. But anyone with money in target-date funds should still confirm that they're comfortable with the risk allocation; in the most recent recession, some funds proved to be overly invested in risky stocks and lost money for investors shortly before they needed the cash.

Don't do anything. A well-diversified portfolio, which reflects an investor's risk preferences and time horizon, should be able to weather storms such as the one the market is currently experiencing. Because downturns often leave portfolios over-invested in more conservative investments and under-invested in more aggressive ones, financial experts usually recommend checking in on a quarterly, or at the very least, annual basis to rebalance accounts.

The worst thing investors can do is to panic when stocks plummet, selling shares and locking in their losses, which also means missing out on the next upswing. And because the market is impossible to predict, even by experts, there's no telling when that could happen.

Twitter: @alphaconsumer