Planning can help consumers prepare for US debt default
With so much as stake if the US government defaults on its debts, here is a primer on how consumers would be affected if Washington remains at an impasse, and the steps to take to protect against losing money.
How are consumers potentially exposed to a debt default?
Retirement accounts and other investment holdings would probably suffer the most as values of both US-based stocks and bonds will likely plummet. Many money market funds hold Treasuries or related debt and will probably be in for a period of stress during a default that would be exacerbated if investors tried to withdraw money in a rush.
Moreover, borrowing costs for many consumers may go up, as loans that have adjustable rates that are either pegged to, or influenced by, Treasuries - and this could include home and car loans and credit card debt - could experience higher interest. Gas prices would probably jump if investors switch from owning US dollars to a commodities such as oil. The safest places, of course, are bank accounts that remain federally insured.
So, is this the time to sell everything and put cash in a bank savings account?
The conventional advice is to sit tight and not sell off your holdings. “The hard part will be to watch it and be concerned - because you should be - but don’t let your emotions cause you to make irrational investment decisions,’’ said Cheryl Costa, managing director of AFW Wealth Advisors and a personal finance blogger for Boston.com.
As Costa and other professionals see it, average investors too often make the wrong decisions about when to buy or sell stocks and other investments: They usually mistime big moves in the market, and sell during a full blown panic when losses are magnified, and then buy too late during the rebound to recover losses.
Is that why the stock market hasn’t crashed yet?
Markets haven’t reacted as strongly to the debt issue as they did in fall 2008, when in the heat of the financial crisis the Dow lost more than 2,000 points in a 10-day period. However, prices did drop steeply yesterday, and the market has been volatile over the past few weeks, suggesting that if Washington fails to come to an accord, there could be a huge drop.
For now, though, many on Wall Street continue to say they don’t believe Washington would ever let a default come to pass, because the financial consequences are too dire. Even if the deadline does pass without a deal, many predict a solution to the debt crisis will shortly follow.
If it does, you’re likely to get a relief rally. Investors who hold their positions during the crisis will profit from that rally, while those who sold will be playing catch-up.
But many investors who followed the “sit-tight’’ advice during the financial crisis of 2008 have only just regained most of the money they lost during that awful period. Isn’t there anything they can do to protect their money this time?
There are a series of small steps investors can take to shore up their savings and portfolios, steps that make sense even in the absence of a crisis.
First, make sure you have enough cash on hand to meet your normal expenses and for unanticipated emergencies. Also, if you’re savings up for a big expenditure - a down payment on a house, a looming tuition bill - it makes sense to keep that money out of the market. Even money market mutual funds have some exposure to the debt crisis.
Then, make sure your investments are well-diversified.
“Think beyond stocks and bonds to things like commodities and real estate,’’ said Bob Hurley, financial adviser with Stoddard Management Co. “Broaden your horizons in terms of asset classes.’’
Diversifying your portfolio is like eating your vegetables: You know it’s good for you, but sometimes skip over it. Many investors let their portfolio targets drift or don’t realize how much they have concentrated in one area, particularly in this case, within stocks and bonds of US companies. Diversify within investment categories and among regions of the world - emerging markets such as China or India, for example. There are any number of index mutual funds or exchange-traded funds that make such investing simple and economical.
For the detail-oriented, you can go so far as diversifying your fixed-income portfolio so you own more bonds and notes of short duration, which should be less affected by the current crisis.
Everyone else seems to be buying gold. Why shouldn’t I?
Gold prices are at stratospheric levels again, as buyers believe it will hold value much better than similar investments - specifically the US dollar, which is being weakened by the financial crisis surrounding the US debt. Many pros think gold is truly at bubble stage, and would be dangerous to buy at these prices. Others, however, argue there are sound, fundamental reasons for thinking why gold will appreciate beyond the current $1,600-plus-an-ounce range, and again, that has to do with the dollar remaining weak because the debt crisis has undermined confidence in the United States.
“I feel very confident that the bull market in gold is going to increase because the US dollar will continue to’’ suffer, said Rob Lutts, president of Cabot Money Management of Salem.
Taryn Luna can be reached at email@example.com.