Four Steps to Crash-Proof Your Portfolio

By Nancy Zambell

Editor of Investment Digest and Dividend Digest

Crash-Proof your Portfolio

4 Steps to Minimize Losses and Maximize Profits

Two Strong Stock Recommendations

Since 2007, the Dow Jones Industrial Average has gained more than 10,000 points, but as you can see from the following chart, the ride has not been without volatility. After the initial rebound following the recession, the market nosed down in the second half of 2011, leaving investors wondering if the bull market was coming to an end. Of course, it wasn’t, and the markets have continued to hit new highs since.

However, what goes up must come down, and while the Investment Digest, which I edit, is all about finding fabulous-and profitable-recommendations for my readers, I would be remiss if I didn’t also offer ideas to protect my readers’ portfolios in times of pullbacks or excessive volatility.

In 2011, investors who merely “stayed the course” had a wild ride, and those who didn’t adequately protect their portfolios probably ended the year in the red. They made the same mistake that many investors make: Although they love to buy stocks, they hate to sell them.

When the market looks enticing, many investors become so excited that they buy stocks willy-nilly, with no thought to creating a balanced portfolio. And when the market drops, they freeze, not knowing whether they should continue to buy more shares to take advantage of the lower prices or just bail out and sell everything. And the sad result is usually this: When under pressure, investors will generally make exactly the wrong decision!

In essence, they fail to plan.

But you don’t have to make the same mistakes. Instead, with a little thought and planning, you can create an all-weather portfolio.

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For the last few weeks, investors have been on a market seesaw, with hundred point daily gains and losses almost becoming the norm. In such volatile markets, it’s more important than ever that you not only consider investing for gains, but also invest to protect your existing portfolios.

Now, I’m not saying you won’t ever lose money, because there are no guarantees in the stock market. But here are steps you can take to minimize your losses and also maximize your profits.

1. Set a price target the day you purchase your stocks. Your target should be based on the P/E of your stock, multiplied by expected future earnings. I recommend that you at least think about what price your stock can achieve within 18-24 months. And that should at least be a 30%-50% gain. If your stocks don’t have that potential, keep looking.

When the stock hits your target, reevaluate it and determine if it has the potential to continue double-digit price gains or if you would gain more by cashing in and using those funds to purchase a different stock with more potential. Many of the contributors to the Investment Digest make this decision easy for you, by providing targets for their recommendations, and often cash in just a portion of a holding to take some profits and let the remaining half ride toward a new target.

For example, in a recent issue of Investment Digest, I featured Barracuda Networks (CUDA), recommended by Jon Markman from New Technology Superstars, who set a three-year price target of $62.25-about 122% higher than the shares were trading at that time. In setting his target, Jon looked ahead at forward analysts’ estimates, saying that, “For the full year, analysts are looking for the company to generate earnings of 16 cents a share, a 60% increase over the previous fiscal year. Next year, earnings are expected to grow a further 56% to 25 cents a share.”

2. Set a stop-loss limit the day you purchase your stocks. For aggressive investors, the stop-loss could be 30% or more. For more conservative investors, you might be happier with a stop-loss of 10%. The actual percentage is not as important as being disciplined in exercising the stop losses. Sure, no one likes to lose money, but a stock riding momentum down can clean you out in no time, so it’s best to take your losses. If the stock bounces back, you can always buy back into it. Many of our contributors provide stop losses for you, but it’s always a good idea to consider your own investing strategies when setting your stop losses.

With technology stocks-which tend to be more volatile than more conservative companies-it’s a good idea to set your stop losses a little wider. For example, with Barracuda, I would suggest a 30% trailing stop. That way, if the market causes the shares to slip a bit one day, it allows you to ride out a temporary drop, without inadvertently cashing out of a stock with excellent long-term potential.

3. Diversify your portfolio to reduce your overall portfolio risk, as well as volatility. That means creating a portfolio with non-correlating assets, which, theoretically, results in assets that react differently to market catalysts. When market action causes some of your assets to decline in value, others should rise, effectively providing protection against your entire portfolio declining at the same time.

Consequently, you should own small-, mid- and large cap stocks; companies in different sectors; and both value and growth stocks.

And while you may think you are properly diversified because you may have 10 different technology stocks that operate in totally different segments, remember that they are all still technology stocks-companies that tend to do very well when the economy is steaming ahead and customers have plenty of money to upgrade. That’s one of the reasons that Barracuda looks so promising.

The company is a fairly new IPO, but is already profitable. And it operates in the fast-growing area of the cloud-a focus to which corporations all over the globe are dedicating enormous resources. Barracuda provides performance, security and storage solutions to corporate IT departments. It looks very promising, and could make a great addition to your portfolio if you don’t have enough tech stocks.

Just make sure you diversify across a broad range of sectors.

You should also have exposure to international stocks, either through owning multinational companies or via exchange-traded funds. And don’t forget about fixed income investments. In 2011, fixed income was the place to be, and bonds are again having a pretty good year, as I write this. As well, some investors may want to add currencies, commodities and real estate to their portfolios.

With 40 or more recommendations coming your way each month in the Investment Digest, you won’t have any problem finding stocks from almost every industry to help you diversify your holdings.

Of course, the actual composition of your portfolio will depend on your personal investment goals, your age and your risk profile, so make sure you know the kind of investor you are so that your portfolio will match up to your goals.

4. Put some dividend-paying stocks in your portfolio. They are a great hedge against inflation and provide terrific portfolio gains in down market cycles. Years ago, during the tech boom, I began adding dividend stocks, such as regional banks and Real Estate Investment Trusts to my portfolio. The payoff was great! When the tech stocks bit the dust and the market took a downturn, I was still earning great returns on my dividend stocks. Many investors neglect these companies as they think they are too boring. But, what’s boring about making money?

The pages of the Investment Digest include a nice array of companies that pay dividends. For example, in today’s Daily Alert, Mike Burnick of Weiss Stock Ratings Heat Maps recommends oil refiner Tesoro (TSO), which carries a 1.8% dividend yield. The company recently agreed to acquire QEP Field Services for around $2.5 billion, including 58% ownership in QEP Midstream Partners. Mike said, “We’ve put Tesoro on our Best Value Stocks Heat Map and rate it a Buy with good growth potential.”

With so much cash available to companies over the past few years, stocks in every sector-including technology and emerging markets-will often pay a dividend. And that just adds to your profits.

For most investors, following these four steps will help you create a portfolio that will thrive through normal up and down market cycles. While an undiversified portfolio can give you tremendous gains-if you are lucky enough to choose only “home-run” stocks-the plain truth is that most investors-individual or professional-don’t have a crystal ball. And stocking your portfolio with just one type of company or sector-no matter how promising-is a recipe for failure over the long-term.

So, do yourself a favor, and take advantage of the tools that are available, including a subscription to Investment Digest! Since we opened the doors to 500 new subscribers, we only have 50 sports remaining. Don’t wait. Reserve your spot today before we close the membership again.

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Sincerely,

Nancy Zambell
Editor of Investment Digest
And Dividend Digest

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