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Would a Default by Greece Be the Beginning of the End?

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Here's the Armageddon scenario: First Greece defaults, then Portugal, then Spain. Will Italy be next? Is the viability of the euro currency an issue?

Will this trigger a second global financial crisis?

Given the spiraling debt in the U.S., is there a possibility the U.S. will default on its debt?

This scenario is breathlessly played out in the financial media and is accepted by many investors as a fait accompli.

Does it have merit? If so, what should you do to protect your investments?

There is some cause for concern. According to John Lipsky, First Deputy Managing Director of the International Monetary Fund, government debt in advanced countries is projected to increase to 110% of GDP by the end of 2014. That can't be good.

Should investors rely on doomsday predictions of distinguished economists? After all, they have the credentials to dispassionately assess this data.

Really?

In an article in the Wall Street Journal on January 23, 2009, Ian Bremmer and Nouriel Roubini ("Dr. Doom") set forth this opinion: "The world's first global recession is just getting started." The authors peered into their crystal ball and advised investors that "...2009 will be tougher than many anticipate."

On January 23, 2009, the DJIA closed at 8,077. On March 19, 2010, it closed at 10,741.

Bremmer and Roubini may ultimately be vindicated. However, investors who relied on their predictions got hammered.

Rather than relying on predictions of any stripe, there are some practical steps you can take to protect your portfolio. Here are my suggestions:

1. Recognize that governments can default on their debt;
2. Avoid the debt of countries in danger of defaulting;
3. If you purchase the debt of these countries, do so recognizing the additional return you may receive is your reward for your acceptance of the higher default risk you are taking;
4. Diversify your bond portfolio to include the debt of many countries and investment grade corporate debt. The best way to do this is by purchasing low cost, bond index funds or Exchange Traded Funds.

The Vanguard Total Bond Market ETF (BND) is a good choice for low cost (expense ratio: 0.14%) exposure to the U.S. Aggregate Bond Index.

For exposure to international bond markets, consider Barclays SPDR Cap Short Term International Treasury Bond ETF (BWZ)(expense ratio: 0.36%). Its benchmark is the Barclays Capital 1-3 year Global Treasury ex-US Capped Index, which measures the performance of fixed-rate local currency sovereign debt of investment grade countries outside the U.S. This index has 229 issues. The top ten holdings include Italy, but not Greece, Portugal or Spain.

Many financial experts believe you should have up to 50% exposure to foreign bond markets in the bond portion of your portfolio.

Given a choice between relying on financial experts with a poor track record of predicting the future and educating yourself to avoid the perils of sovereign debt, the choice is obvious. No one cares about your money as much as you do.

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