O’Connor: Investors urged not to panic as U.S. default looms

Last Updated: July 27. 2011 1:00AM

Brian J. O’Connor

O’Connor: Investors urged not to panic as U.S. default looms

Many doubt leaders, in the end, will fail to act, trigger default

With the deadline to raise the federal debt ceiling drawing closer by the day — and the risk that the U.S. could default on its sovereign debt growing — individual financial planners are fielding lots of calls from worried investors.

A failure to raise the debt ceiling that prompts a U.S. default would cause stock and bond prices to plummet, interest rates to rise, credit for mortgages, cars and other debt to pucker up, and knock the wobbly economic recovery flat on its face. Federal Reserve Chairman Ben Bernanke himself has warned that letting the federal government run out of money would be “catastrophic.”

Nonetheless, advisers say individual investors should stick to their investment strategies for three good reasons:

First, most planners doubt that even the kinds of people who get elected to Congress these days will really allow the U.S. to default on its debt.

Second, in the case of a cataclysmic financial disaster, the traditional safe havens, such as U.S. Treasuries and even greenbacks, would take a hit.

And third, most individual investors just bungle it when they try to time when to enter and exit the stock market. “You’ve got to know when to sell but when to buy back in, too,” says Lyle Wolberg, a certified financial planner with Telemus Capital Partners in Southfield. “So you’ve got to be right twice. And that’s hard to do.”

Financial experts all agree that a U.S. debt default would be a serious, serious issue. But would it be as big as the worst global crash since the Great Depression? After all, the Dow Jones index has recovered nearly 90 percent of its record high from late 2007, at the peak of the real estate bubble. So unless you’re sure a possible U.S. default would create another great recession, it may not be worth the cost and worry to start rearranging your investments.

And even if it is, a well-structured investment portfolio already is positioned to ride out those kinds of losses.

“The diversification we’ve had in place is to address all these issues, so there really are no moves to make,” says Bill Mack, a certified financial planner who runs William Mack & Associates in Troy. “If you’re in inappropriate investments now, especially if you’re too heavy into equities, I’d be concerned. But this is a short-term event and your portfolio should be geared toward long-term objectives.”

With bonds, stocks and even U.S. Treasuries taking a hit in a default, investors really don’t have many places to run. Some analysts have suggested Swiss francs, an investment that’s well beyond the means and expertise of most folks trying to protect a 401(k) or Individual Retirement Account. Other strategies — from the popular but very risky choice of gold, to moving from long-term to short-term bonds or switching to high-dividend-yielding blue-chip stocks — are common suggestions.

But those strategies have been in place for more than year now, as investors anticipated rising interest rates, more inflation or looked for safe income to replace low-yield Treasuries.

“There isn’t a whole lot you can do that hasn’t been covered by the markets,” says Karen Norman, a certified financial planner with Norman Financial Planning in Troy. “Positioning yourself other than running for cash is tremendously difficult.”

Even cash would lose some value as the dollar would decline after a default, making it more expensive to buy imported goods, including gasoline. The advantage would be that a switch to cash now would leave an investor positioned to go bargain-hunting when stocks slide after a default. But individual investors who make regular contributions to a 401(k) or IRA already buy more shares with every deduction from their paychecks or automated payment from the checking accounts, so they’re already positioned to buy low once stocks hit the skids, just as they’ve done throughout the entire downturn.

The reason to go to cash now, says Nina Preston, a certified financial planner with the Society for Lifetime Planning in Troy, is if you need a stable stash to cover your short-term income requirements, such as retirees who are counseled to hold three to five years worth of needed income in cash or equivalents. But if you need to do that, you’re already holding too much stock.

“If you need to flee to cash,” Preston says, “you should have been in cash to start with.”

The final drawback to moving your money around — even to cash — is that you’ll probably do the wrong thing, warns Mack.

“If people are adamant about going to cash, if they feel it in their bones that the world is coming to an end, at what point do they say, ‘It’s time to get back in?'” he asks. “Don’t tell me its when you feel better because that’s too late. It just doesn’t work to follow your gut feelings.”

The bottom line is that investors need a strategy that lets them ride out short-term economic woes, even if they’re self-inflicted by our own leaders.

“We’ve looked ahead and positioned ourselves the best way we can,” Norman says. “Now we need these folks in Washington to do their duty. That’s what we’re paying them to do.”

Which means that your best investment option is a very easy one — picking up the phone and placing a call to your congressman or congresswoman.

boconnor@detnews.com

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Solve the Deficit Problem by Cutting Government Spending – You Don’t Stop the Spending by Refusing to Increase the Debt Ceiling

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Jane M. Young, CFP, EA

A few clients and friends have asked me if they should be making changes to their investment allocations based on the uncertainty around raising the debt ceiling. While we don’t want to bury our heads in the sand we should not over react to something that probably won’t come to pass. In my opinion the political stakes are way too high for all parties concerned to allow the U.S. to default on its obligations. At the moment everyone is playing chicken but at the end of the day, neither party can afford the political fallout that would result in a failure to raise the debt ceiling. This does present a great opportunity for the media to get attention with sensationalistic, doomsday headlines to help them sell newspapers or television spots. This is also a great opportunity for political posturing on the part of both Democrats and Republicans. It is my projection that on August 2nd we will still have a huge deficit problem and a higher debt ceiling.

The debt ceiling is an indication of a much bigger problem with federal government spending. The problem is not solved by changing the debt ceiling; the problem was created when congress approved spending resulting in the need to raise the debt ceiling. Failure to raise the debt ceiling is like trying to close the barn door after the horse has gotten out. Refusing to raise the debt ceiling is a meaningless gesture, with regard to our deficit. However, it carries a catastrophic impact on the perceived safety of U.S. debt which would ripple down through all aspects of our financial lives. This is clearly not an acceptable course of action. The real issue is getting a handle on government spending and the deficit which will require major reforms to Social Security and Medicare. Our economy and prosperity are being held back by a looming black cloud caused by fear and uncertainty with regard government spending and the federal deficit.