3 simple steps to ‘stress test’ your share portfolio

As the old saying goes, time spent preparing for tough times while the sun is out is rarely wasted. For your finances, this can be done by running the companies you own through a simple ‘stress test’ to find potential points of weakness if trouble hits.

This is especially valid after almost two years of strong and steady growth by the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO). It is not hard to find that the companies you own are overly weighted towards one particular industry, country or region, and you don’t have to look far to see how that can go wrong.

Since the price of gold started falling in 2011, shares in Australia’s largest gold miner Newcrest Mining (ASX: NCM) are down 72% over the last two years, while fellow gold producer Silver Lake Resources (SAX: SLR) has lost almost 80% of its market capitalisation.

There are three easy steps to follow to check how the companies you own stack up.

1.  Identify your time horizon

It’s important to understand when you will need the money you have invested. This will influence the types of companies you want to be holding in your portfolio. For example, a five-year time horizon may give shares in Newcrest Mining time to recover, but investors needing to cash out in the next 12 months may face a problem.

2. Find your weak spots

Weak spots can be uncovered by looking at how much diversification you have in your portfolio and thinking about what could go wrong. Major events like natural disasters, wars, economic meltdowns or industry crises should all be considered.

It’s not hard to quickly find yourself overexposed to a particular industry or country. For example, both banks and insurance companies have exposure to the volatility of financial markets — IAG (ASX: IAG) and ANZ (ASX: ANZ) both suffered big falls in share price over 2007 and 2008 as the financial crisis took hold.

3. Strengthen your weak spots

Once you’ve found any weak spots, you can take action. This can be done by reducing your exposure to the area you identify or spreading your risk over other countries or industries.

Foolish takeaway

A basic review of the areas you are exposed to will help ensure you don’t get caught out if things turn bad. Re-affirming your time horizon and identifying weak spots will help to strengthen your portfolio.

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Motley Fool contributor Regan Pearson does own shares in any of the mentioned companies.

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