Thinking Outside Pandora's Box -- How to Protect Yourself From the Eurozone Debt Crisis Fallout

11/11/2011 10:09 am ET Updated Jan 11, 2012

Watching the drama unfold in the Eurozone, one can't help but draw parallels to ancient Greek mythology. Icarus' hubris and Pandora's Box are just two comparisons that come to mind, as the grim realities of default and contagion hang over the global economy like the sword of Damocles.

The debt crisis that plagues Greece is becoming more of an epidemic in Portugal, Ireland, Italy and Spain, leaving European financial institutions -- and their investment in foreign governments (sovereigns) -- in jeopardy for in excess of a trillion Euros. Can the United States and you, as an investor, escape unscathed? Here are five steps you should take to protect yourself and your portfolios:

1. Stay Liquid. Now's the time to be careful at home and overseas. Risks abound in Europe, as well as in the extraordinary amount of federal debt we have here in the U.S., so be conservative. Stay liquid by investing in short-term funds that will produce some income and still provide one-day liquidity. This not only will stabilize your assets, but allow you to take advantage of opportunities that arise when there is resolution in the Eurozone banking system, as well as to the political turmoil here at home.

2. Avoid European Banks. Recently Dexia, the major Franco-Belgium bank, required a bailout due to liquidity/cash-flow issues. The Wall Street Journal reported in October that, "As recently as July, the Franco-Belgian lender passed European bank stress tests. Its core Tier 1 ratio, a key measure of capital strength, was a sturdy 10.3% at the end of June." Tier 1 capital measures a bank's financial strength from a regulator's perspective. It represents the ratio of a bank's core equity capital to its total risk-weighted assets (RWA). The Dexia bailout may be the beginning of a series of bank failures to which no investor wants to be exposed.

3. Be Wary of U.S. Banks, Too.
Not only should you stay away from European bank stocks, you should be very selective about investing in the U.S. banking sector as well. If you have an appetite for the sector, choose well-capitalized institutions that can withstand the hits that are coming from across the Atlantic. But first, check their Euro debt exposure. According to Fitch Ratings, the ten largest U.S. prime money market funds had $309 billion (almost half their total assets) in debt obligations issued by European banks, as of July 31, 2011.

4. Look to Precious Metals.
Bank liquidity remains stretched and will all but snap if Southern Europe "goes south." In the meantime, it appears Europe is taking steps to take a "keep calm and support the weaker siblings" approach. To hedge against inflation, we advise clients to diversify a portion of their assets into precious metals, including gold and silver.

5. Evaluate Utilities and Dividend-Paying Equities.
Now is a good time to consider adding high-yielding, energy-related investments and commodities that have bullish long-term outlooks and attractive yields. In other sectors, higher yields from selected dividend-paying equities can help bolster your income -- a smart place to put some of your cash, especially in light of what you can earn relative to a bank CD or money market.

As with all Greek tragedies, this crisis is going to have to play itself out. Remember, look at the bigger picture -- investing takes time and patience. To obtain a truly satisfying long-term rate of return, don't lose your head trying to make radical short-term adjustments. A wise investor will take thoughtful measures to protect their assets and hedge against inflation before the curtain falls.

This information in this article is general in nature and may not apply to your own financial situation. Please consult your own professional tax, and/or financial advisor regarding this information and your own personal financial needs. For a complete disclosure statement, please see my biography.