JCP  JCPenney J.C. Penney JC Penney store mall shopping exterior 2013
AOL/Cassandra Hubbart
If you're an investor, at some point, at least one of your investments will turn out to be a colossal failure. In fact, it's quite likely that over your lifetime, you'll invest in multiple companies that don't live up to the expectations you had at the time you bought their stock.

When an investing flop happens to you, you'll want to be in a position to simply lick your wounds and move on, with no real impact to your life. But to do that, you'll have to set up your portfolio in advance to be able to handle those failures successfully.

Can You Tell in Advance?

Take clothing retailer J.C. Penney (JCP) as an example of a company that may now be on the road to bankruptcy. Its cash flow problems and debt hangover are incredibly apparent today, but it wasn't so long ago that it looked like it had a solid future. Its shares peaked above $86 in February 2007, and its annual report published in 2007 included the chart below showing how an investment in J.C. Penney trounced the market over the prior five years:

Chart from JC Penney annual report for the year ending Feb. 3, 2007.
Chart from J.C. Penney annual report for the fiscal year ending Feb. 3, 2007.
Indeed, J.C. Penney had a lot to be proud of in its heyday. In that same annual report, it boasted of earning $4.96 a share in profits and raising its quarterly dividend to 20 cents a share. Unfortunately, as we all know, the retailer's fortunes have changed dramatically for the worse. J.C. Penney hasn't paid a dividend since 2012. In addition, the company's recent announcement that it closed the fiscal year with more than $2 billion in liquidity simply calls attention to how precarious its situation is. Its stock has tumbled to the neighborhood of $5.

While there's still a chance that J.C. Penney can turn itself around and avoid bankruptcy, at this point, it'll certainly be an uphill battle. But still, to an investor looking at the company in early 2007, J.C. Penney looked like a decent growth story, not a potential disaster.

What Can You Do About It?

Unless you've got a working crystal ball, you've got almost no chance to sell at the high-water mark of any company's stock. Instead, one of the best things you can do is diversify your investments so that the fallout from any one company's failure doesn't destroy your overall portfolio.

Until December, for instance, J.C. Penney was a member of the S&P 500 Index (^GSPC). The S&P 500 and the SPDR (SPY) ETF that tracks it had a stellar 2013, even as J.C. Penney was busy falling apart as a member of that index.

Diversification won't keep you from making investments that go bad, but what it can do is protect your overall portfolio from the implosion of any one part of it. The difference between how J.C. Penney performed and how the S&P 500 performed in 2013 is a key case in point of how diversification can protect your portfolio.

In addition to diversifying, you should regularly review each of your investments to make sure it's still worth owning and still playing an appropriate role in your portfolio. If you buy individual stocks and bonds, you need to make sure the companies behind those investments are still operating to expectations and are reasonably valued in the market. If you buy funds, you still need to rebalance to keep any fund or asset class from growing to be a disproportionately large part of your overall portfolio.

The Foundation of a Decent Plan

No matter how you invest, the one-two-three combo of diversification, review and rebalancing plays an important role in protecting your portfolio from the catastrophic failure of any one part of it. Still, there are times when the overall market will swoon and reduce the value of darn near everything you own. For those times, you need the patience to let the market do its thing and the confidence in the long-term strength of your overall strategy to see you through. With an overall plan built in a way that protects you from getting wiped out from the inevitable failure of part of your portfolio, that patience and confidence is a lot easier to achieve.

Motley Fool contributor Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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AL---used to goof off alot on here but I've read his post lately and I believe he's really saying it like it is. I agree...Warren made 95% of his money on insurance and for him sitting on cash...well you gotta have money to make money. If a company that's worthy of being bought comes up for sale...he'll have the money to buy it. I'm also wondering if alot of that cash is sitting in bank acccounts off shore and he doesn't want to get taxed for it here in America. Either's great to be rich if you are, must've been nice to be born back in the 30's and 40's after WW2 created a huge economic boom for that entire generation. We don't have a boom just doom and gloom.

February 25 2014 at 10:31 AM Report abuse rate up rate down Reply
1 reply to davefromfwb1's comment

well you gotta have money to make money.******* Berkshire's net worth is $143.688 Billion. Berkshire Hathaway began its life as two separate textile manufacturing companies, one based in Rhode Island, the other in Massachusetts. The two companies, Valley Falls Company, and Berkshire Cotton Manufacturing Company, merged in 1929, to form Berkshire Fine Spinning Associates. In the mid-1950s, Berkshire Fine Spinning merged with Hathaway Manufacturing Company, another Massachusetts-based textile firm, to form Berkshire Hathaway. The textile industry had begun to fall of somewhat after the 1920s, and Hathaway had encountered cash flow issues, however, the merger seemed to stabilize both companies somewhat. In the early 1960s, entrepreneur and sometime musician, Warren Buffet, purchased shares of the company. However, the textile business continued to decline, so Mr. Buffet decided to sell his shares. He, and the primary owner of Hathaway, agreed on a selling price, but when the paperwork arrived, Hathaway's owner, Seabury Stanton, had altered the numbers. In a fit of pique, Warren Buffet decided not sell. Though it was not a wise financial decision, since the company was failing, Mr. Buffet has since diversified the company's holdings, and turned it into the eighth largest public company in the world. The company now owns and operates an insurance arm, including GEICO, an utilities and energy group, multiple clothing manufacturers, including Fruit of the Loom, building products manufacturers, financial groups, and multiple retail arms. It employs 260,000 people. 95% from insurance? Really? I think NOT.

February 25 2014 at 12:11 PM Report abuse rate up rate down Reply

Warren Buffett is on here again giving investment advice. Buffett doesn't even know what a megabyte is. Half of Buffett's holdings are in cash and cash equivalents.
He didn't make it investing, he made it selling insurance. GEICO ads play 24/7 (fifteen percent in fifteen minutes, boots and pants pig, English accent lizzard creature thing, etc)
Buffett started putting money into the stock market as a place to park the billions he is making from insurance. Has nothing to do with investing savvy.

February 25 2014 at 8:01 AM Report abuse +1 rate up rate down Reply
1 reply to alfredschrader's comment

"The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Cash is going to become worth less over time. But good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it. We always keep enough cash around so I feel very comfortable and don’t worry about sleeping at night. But it’s not because I like cash as an investment. Cash is a bad investment over time. But you always want to have enough so that nobody else can determine your future essentially."

~ Warren Buffet
M0 r0 n

February 25 2014 at 8:14 AM Report abuse -1 rate up rate down Reply
2 replies to ted_wilson6's comment

I agree with you ted.
Inflation will erode the purchasing power of cash investments.
There are ways to invest cash to improve your purchasing power, if you are interested.
If you have the cash, for one, pay off your house and stop making interest payments.
Use the cash to improve your efficiency, upgrade your insulation and SEER ratings, add solar, switch to energy efficient lighting - things to reduce your bills and your stress. Pay off your vehicles and credit cards.

February 25 2014 at 8:53 AM Report abuse +1 rate up rate down

My reply wasn't about the erosion of cash, it was in reply to your constant lying bullsht !

February 25 2014 at 9:18 AM Report abuse +1 rate up rate down