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Dealing With Junk in the Trunk

The GM debt downgrade could leave you overexposed to risky assets. Give your portfolio a tune-up.

As a former Camaro driver, it hurts to hear people calling

General Motors

(GM) - Get Report

"junk."

Back in the 1980s, we Jersey girls took our cars -- and our hair -- very seriously.

So when Standard & Poor's downgraded its ratings of GM to speculative grade, or junk status, last week, I couldn't help but take a trip down memory lane. Maybe if more of us droveCamaros instead of gas-guzzling SUVs, the world would be a better place? (Granted, Camaros aren't exactly hybrids and hairspray does kill the ozone.)

But my feelings aren't the only things hurting these days. If you hold GM bonds, your portfoliocould be in a painful position right now too. On the day of S&P's downgrade last Thursday, the price of GM bonds maturing in 2033 plummeted 4.454 to 74, or $56.77 per $1,000 invested, according to

The Wall Street Journal

, its yield rising to 11.494%.

Since GM is the largest corporate debt issuer out there, there are plenty of folks wondering what to do with these junk bonds.

So you have some decisions to make. You have to revisit your portfolio and potentially make some changes in the diversification of your bond holdings. And if you own the GM stock as well, you may now have too much risky exposure to the company.

Junk Your Debt

Standard & Poor's blamed GM's reliance on big SUVs for the downgrade to junk, but underfunded pensions and rising health care costs aren't helping its situation much either.

And while the market has been losing patience with GM for some time now, it has basically beentreating all GM bonds as junk anyway. But you may not have been.

If you created your portfolio years ago and were originally looking for high-quality corporate bonds because your investment objective was to be safe, buying GM was a good choice at the time.

"But what you're now holding are high-yield bonds that are not so safe anymore," says Hui-Chien Chang, director of fixed income at the Schwab Center for Investment Research. "And it's not likely that it's going to turn around anytime soon."

So first determine when your GM bonds will come due.

TheStreet Recommends

If they're due within the next two or three years, most pros believe the company has adequate cash flow to make those coupon payments. If, on the other hand, the due date is further out, you have to decide if you're willing to live with the risk.

Because while you don't want to believe that a company like GM could default on its loans, at this point, anything's possible.

After you determine what you're keeping and selling, you then need to review all the debt in your portfolio. You don't want more than 20% in one industry and 10% in one issuer, says Rande Spiegelman vice president of financial planning at the Schwab Center for Investment Research. So in the GM case, that means no more than 20% in the automotive industry and no more than 10% of your debt holdings in, say, GM.

Granted, these percentages are just guidelines. You know your situation best. So don't make a knee-jerk reaction and sell the bonds today. Think it through. Quite frankly, you may want some high-yield bonds in your portfolio and GM's are probably some of the best "junk" out there.

If you own bond funds, pull out the prospectus and read up on what happens when investment grade bonds turn to junk. Some funds will require your manger to sell those bonds. Be sure to check out this story, "

Bond Funds Have Leeway on GM, Ford," for more details.

Don't Take Too Much Stock in GM

Now move over to the equity side of your portfolio. It would not be uncommon for folks to own both GM's stock and bonds, especially since the stock pays a hefty 6% dividend. (On Monday, GM said it would pay its regular 50-cent quarterly dividend on June 10 to holders of record May 19.)

And while no one thinks the company is going to shut its doors tomorrow, you still might need to rethink your long-term plans with the company. In short, make sure you're not too heavily weighted in GM stock.

In addition, if you hold a few different auto makers, you may need to rejigger your allocation so that you don't have too much exposure to that industry.

Granted, it's very hard to believe that GM could default on its bonds,

cut the dividend on its stock or even shut its doors, but anything it possible.

Enron

and

Worldcom

certainly taught us that.

So prepare for that possibility. Keep on top of your portfolio. Set up market alerts on your holdings and remember: "Buy and hold does not mean buy and forget," says Spiegelman.

So you promise to never forget about your portfolio -- and I promise to never forget about my big-hair, Camaro-driving days.