Preparing for the Fiscal Cliff

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Jumping off a cliff is usually not recommended behavior (unless you are Felix Baumgartner – who jumped off the balloon lifted capsule 24 miles up on October 14, 2012 to set a sound barrier record).

Jumping off a fiscal cliff is no different, yet it seems, like a bunch of lemmings, we are all running hard and enthusiastically towards the cliff edge.

The term fiscal cliff – as you no doubt know already – was coined by Ben Bernanke to name the group of legal changes due to hit in January 2013 – a messy mass of new and expiring laws around taxes and deficit reductions.

It seems there is no good option among the various ones being kicked around. If nothing is done by congress, severe budget cuts are enacted, costing jobs in the government sector and all kinds of tax cuts get rescinded. All of which will result, according to the Congressional Budget Office, in the situation where

“real economic growth would decline at an annual rate of 2.9 percent during the first half of 2013. Unemployment would rise to 9.1 percent by the end of next year.”

In other words, the recession’s back baby.

But, even if congress takes action to mitigate the effect of the cuts and tax increases, the government’s debt will be downgraded by Moody’s (they already promised it!) – probably causing the markets to roil and boil again.

In either case, something’s shakin!

What does the fiscal cliff mean to you?

  • Payroll taxes bounce back hitting your paycheck by about $80 a month.
  • Your taxes increase – if you make good money – due to ObamaCare.
  • Your taxes increase – if you are an average or low earner – due to the expiration of the earned income credit, child tax credit and college tax credit.
  • The alternative minimum tax will kick back to prior levels and will kick in at lower income rates.
  • The economy will shed jobs – government jobs due to budget cuts as well as private jobs due to higher payroll taxes and ObamaCare taxes.
  • The stock market may plunge as we head back into recession.
  • The bond market may suffer if a short term solution is reached.

How bad could it be?

Fidelty Viewpoints says that if nothing is done and we hit the worse-case scenario,

“According to our research, corporate earnings could decline by double digits, perhaps as much as 20% or more. If this happened, it would have a tremendously negative impact on the stock market and other riskier asset categories.”

Are you concerned?

The stock market is near all time highs. The real estate market is reported to be recovering. The job situation has slowly, slowly been improving. What’s the problem?

If you aren’t paying attention to the fiscal cliff, you might want to think it through. US News believes you should prepare for a lot of volatility and reported that:

“Wall Street analysts think the time around the end of the year could be similar to August, 2011, which was when a big, needless fight over extending the nation’s borrowing limit led to the first-ever downgrade of the U.S. credit rating by Standard & Poor’s. The stock market fell by 7 percent and took six months to recover its losses.”

Money Morning interviewed several financial gurus and noted the following:

  •  David Kostin, from Goldman Sachs thinks the fiscal cliff is a big deal and that equity investors are ‘unduly complacent’ about it.
  • Jim Rogers, the commodity guy, recommends taking long term capital gains (since they may very well be taxed more in 2013) as well as purchasing commodities such as precious metals, mining stocks and related exchange-traded funds (ETFs).
  • My own 39 year old son is considering getting out of the market for awhile, however Money Mornings own Chief Investment Strategist Keith Fitz-Gerald disagrees. He says:

“Investors have to be in markets. You have no choice,” advised Fitz-Gerald. “The real risk is not getting wiped out, but rather getting left behind. The last three stimulus efforts have led to double digit rallies. Get your buy list ready. History shows beyond any shadow of a doubt that staying in the game is good, but buying when stuff hits the fan is best.”

  • But, on the other hand, Bill DeShurko, CoVestor Model Manager, told Forbes,

 “There is absolutely no reason to lose another 30-40% of you investments for the third time in the past 12 years. Buy and hold strategies will once again wipe out wealth that individuals can no longer afford to lose.”

What to do?

Who knows?! The situation could resolve any number of ways. Perhaps that is why more investors appear to be complacent.

Here is what I’m doing, but this is not a recommendation about what you should do!

Halting stock market and mutual fund purchases for now.

I’ve been trying to get some retirement fund proceeds back into the market. I had to cash them out to move my 401K to an IRA because the 401K administrator had them in institutional class funds which couldn’t be moved.  I’ll think about starting to make purchases in first quarter, depending on what happens.

Taking some capital gains.

I’ve sold some company stock this year, but had intended to no matter what because I think I have too much of it. This is a double whammy.  I get the cash and we pay the lower cap gains rates for 2012.We will again review our market positions to see if there are other securities that don’t fit with our current desired allocation or needs. If so, we will try to get them sold as well – without bumping up into that next tax bracket!

Keeping a large cash position.

We already had a big cash position due to my retirement 2.5 years ago. I saved my entire last year’s salary to build up funds for post retirement needs. Although the funds will eventually be given away, invested or spent, for now, they will stay tucked away in case we need them.

I’ve always been kind of a buy and hold type gal, but I sure don’t want to see our net worth sink by a third again – 5 years later! I hope, come January, I don’t stare into the woods thinking, why oh why didn’t I sell more stocks back in October!

What do you think will happen after the election? Is our fragile economy due for a severe downturn?  Will we face a real fiscal cliff?

Other resources:

This post has been written by Marie from FamilyMoneyValues.com. Be sure to visit her site if you’ve enjoyed this post.

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Investing Money

Derek

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

14 Comments

  1. Hi Marie! Great post.

    Suze said in 2011 that there will be another big market downturn by the end of 2012, and honestly, I just have a feeling about it. You provided great evidence that makes me feel like I should listen to my gut!

    We would never touch our retirement accounts (we are around 30 years of age), but I have kept money on the sidelines of the stock market for some time now that is waiting to take Buffett’s advice of “buy low, sell high”.
    Amanda L Grossman recently posted..Frugal Confessions Friday – Frugal Living

  2. I don’t think the cliff is really going to be as bad as everyone says. Most of it is scare tactics. Oh now, payroll taxes will go up! BY TWO PERCENTAGE POINTS. If that happens, I loose out on $9 each paycheck. Big whoop. For those without capital gains to claim and already have insurance, ObamaCare taxes are just the 0.9% Medicare tax increase. Which is $4 per paycheck for me.

    I can live with my paycheck being $13 smaller.

      • It’s only going to be a huge hit for people who get a lot of their income from capital gains. The average taxpayer is probably going to see their tax burden go up by a couple hundred dollars.

        Personally, I think the market needs to suck it up. It’s annoying to have people treat the stock market as some sort of deity that you have to worship and treat with deference because if it gets upset, it will smite you! The market over-reacts to news because everyone has decided that the market should react certain ways to certain kinds of news and so fulfills that expectation.
        If everybody said, okay, taxes are going to be restored to where they were before they were TEMPORARILY lowered and stopped calling it a cliff that we are all going to be plunging to our deaths, then the market would react quite well to it.

  3. I believe that something will get done. One thing that I think has to happen at some point is not just to extend things but either make them permanent or come up with an exit timeline, so that the economists and the citizens know exactly what is coming. Don’t just push it out ten years and leave it for someone else to deal with, or push it out a year and figure we’ll get to it then, but these politicians need to do the job they’re elected to do, and I’m tired of them ‘kicking the can’ down the road. That’s getting us nowhere
    Money Beagle recently posted..Fixing A Little Thing Is Easy And Can Keep You Happy

  4. Awesome article Marie! I sure hope this article goes viral because it’s important for everyone to read before we head into 2013.

  5. We aren’t holding back on purpose, but we have been putting way less into the market in the last year. We’ve been paying off mortgage debt instead. I love guaranteed returns and hate all debt, so that will probably be our main focus for at least another year or so…

  6. I’ve pulled about 60% of my portfolio back to cash, and 50% of 401k contributions are going to cash, all until at least after the election and possibly until Jan 2013. That may kick me in the butt for not getting any increases between a couple weeks ago and then, but for all intents and purposes I’ve locked in my increases I managed to attain for the past 2 years.
    Great article BTW!
    Chris recently posted..Cashier stated it was not necessary to paying in full, WWYD?

      • Actually, the risk to me is only that I will not get any appreciation that MAY occur between now and when I decide to get back in the market.

        I don’t really care for the fumbling that our Congress & Senate are currently doing around the same time as the election with the “fiscal cliff” approaching. Therefore, I’ll most likely stick it out for a few weeks or more depending upon how the market looks then.

        I work with a guy who hasn’t been in the market in anything more than bonds since 2004. His returns are about half of what mine are over the same time period (and mine are mostly the last 2 years), but sitting out too long isn’t the best option either IMHO. Have a great day Marie! 🙂
        Chris recently posted..Cashier stated it was not necessary to paying in full, WWYD?


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