The 2007 Bunker Portfolio

Four safe and smart strategies—and one riskier play for the truly bearish—for investors who expect the worst

by Ben Steverman

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No one really knows where the stock market is going. Is the late-July plunge in stock indexes a momentary blip, or a sign of worse things to come? Will credit troubles and the ever-lower housing market do in the rest of the economy?

One thing is clear: Markets have entered a period of wild volatility. Indexes hit record highs and a week later fell almost 4% in two days.

"That is a sign the market is changing," says Hossein Kazemi, finance professor at the University of Massachusetts at Amherst. "There is a divergence of opinion" among investors, he says.

For this Five for the Money, we look at what investors can do to prepare for the worst. We call it our Bunker Portfolio. Feel free to compare this with last summer's edition, when the big worry was tension in the Middle East (see BusinessWeek.com, 7/17/06, "The Bunker Portfolio").

Before we lay out a few strategies, though, some warnings courtesy of the financial advisors we consulted for this story:

Risk is part of investing. If you're investing for the long term, don't get spooked just because of a little bad news. You can miss out on a lot of upside if, as often happens, the worst fears aren't realized. Also, don't make any sudden moves you will regret. If you switch strategies too often, trading costs may eat up your returns.

If, however, you're going to need to cash in your investments soon—for retirement, tuitions, or a home purchase—it makes sense to keep your money in a safe place. As Austin (Tex.) planner Morgan Stone points out, a market crash just before you need the money would be disastrous.

Also, if you really believe stock prices have peaked and the economy is facing a world of hurt, a safer investment strategy just might help you sleep better at night.

Whatever happens, here are five ways to help your hard-earned cash survive downturns and disruptions. We start with the most conservative—some might say boring— strategies and move on to riskier ways to prosper if things get dire.

1. Cash

If you're really worried, "there is no shame in being in cash," Kazemi says. With cash you'll lose out on big returns, but you won't lose any of your principal.

If you do cash out of other investments, there are better places to put the money than burying it in the backyard. Money-market funds provide an entirely safe spot to park cash while still getting a decent return. Marshall Groom, a financial advisor based in Richmond, Va., recommends the Vanguard Prime Money Market (VMMXX) fund. Another risk-free option is bank certificates of deposit, which are insured (up to $100,000 at any one bank) by the federal government. CDs, however, lock up your money for a period of time, often at least six months.

Advisors recommend that you have at least some of your portfolio in cash at all times. Cash worth at least three or four months of expenses can help out mightily in an emergency.

Kazemi suggests the extremely cautious investor might wait on the sidelines in cash until October, when the ride might be a little less wild.

2. Bonds

The safest investment out there may be government bonds. Yes, prices can fall, but you're guaranteed a certain return if you hold the bonds until maturity. TIPS bonds are guaranteed to beat inflation, which can sap your portfolio's buying power. If things get bad, an interest rate cut by the Federal Reserve might boost bond prices.

Until recently, markets gave investors little incentive to invest in somewhat-riskier corporate bonds. Yields were barely higher than those on government debt. "The market basically ignored risk," says Micah Porter, president of the Minerva Planning Group in Atlanta. With the recent credit crunch, that's starting to change. Porter says it may make sense to buy corporate bonds, but he recommends only those with very high grades that will hold up if the economy worsens, defaults rise, or the credit crisis deepens.

3. International funds

Most advisors say international investments are part of any diversified portfolio. Much of the world's economic growth is expected to come from outside the U.S. For risk-averse investors, international exposure lets you avoid the impact of disruptions in the U.S.

Countless mutual funds and electronically traded funds (ETFs) let Americans invest cheaply abroad. International investing also helps protect against a declining U.S. dollar. But a few warnings are necessary:

Emerging markets such as India and China are booming, but they may be less stable than the U.S. There is less market research abroad, and regulations that protect investors aren't as strict, says Avani Ramnani of Athena Wealth Advisors in Jersey City, N.J.

Barbara Camaglia, of Ohio-based Legacy Financial Advisors, says it's important to distinguish between emerging markets and developed markets. Stocks in Europe are no more risky than U.S. stocks, she says.