Personal Finance : How to Protect Your Portfolio From Politics

All the dithering about raising the debt ceiling sent the stock market tumbling last week, as investors faced down the prospect of a "double dip" recession. Given the sorry state of Washington, a reasonable person might ask: is there any way to protect our portfolios and cope with the ramshackle global economy at the same time?

Yes, but it calls for a strong stomach, a handle on your own financial goals, and the ability to tune out the noise. That's the lesson of the debt-ceiling talks, says David Kelly, chief market strategist of J.P. Morgan Funds. Friday's stronger-than-expected jobs number (which added 117,000 jobs to nonfarm payrolls and sent the unemployment rate down to 9.1 percent) also brought revisions upward in the jobs numbers for May and June. In other words, things the past three months, while not good by any means, were also not as bad as we thought.

In order to stay out of the fray, individual investors need to focus on controlling the things they can control, says Mark Zandi, chief economist of Moody's Economy.com. We can't control Washington, but we can take charge of our investments. Here's how:

Maintain enough liquidity. There's a big difference between the money you need to make that first college-tuition payment for your daughter in 2013 and the money earmarked for your retirement two decades from now. To safeguard the tuition, you need to protect yourself against having to sell in the middle of a market correction, says financial adviser Harold Evensky. He's advising clients to keep five years' worth of necessary cash in either cash itself or fixed-income instruments like CDs and Treasuries with short durations. Short is important, because when interest rates rise you'll want to be able to transition fairly quickly into better-paying safe havens.

Increase your diversity. When you built your portfolio, you should have decided on a ratio of stocks to bonds that made sense for your age and risk tolerance. Maintaining that mix (and making sure you've got a wide array of stocks and bonds—domestic, international, growth, value, large cap, small cap) is key. But it's also now clearly important to invest in alternative assets—ones that move in opposition to the broad markets—so that if your stocks and bonds take a beating, you have something else to hold you up. Precious metals, oil, and cotton all fall into this category. The best way to buy these is through a mutual fund like Fidelity Select Natural Resources, says financial adviser Gary Schatsky of ObjectiveAdvice.com, who also points out that these categories are an inflation hedge.

Make sure you're saving enough. One fact illuminated by the recent debates in D.C. is just how unsustainable the country's entitlement programs actually are. "They will need to be scaled back or we'll have tax increases," says Zandi. As the former approach currently has the upper hand, ramping up your retirement savings to cover not just your cost of living but the projected $200,000 to $250,000 that a 65-year-old couple will need for health-care expenses not currently covered by Medicare is a good idea. If you don't know whether you're on track to cover your retirement needs, go to choosetosave.org and run the ballpark retirement estimator. And when the calculator asks you how long you're going to live, be optimistic: the best answer, for planning purposes, is "no less than 95."

Don't let your myopia get the better of you. When times are good, investors tend to think the party will never end. So they overborrow and put too much in stocks, only to be taken down by one bubble or another. When times are bad, investors think that will never end. So they pull their money out of the market and sit on the sidelines, missing great market runs like the one we had in 2009. Says Zandi: "It's the folks who can see through it all, taking reasonable chances during good times and bad, who are rewarded."

Chatzky, NEWSWEEK's personal-finance editor, is financial editor for NBC's Today.