The debt ceiling crisis largely left the news cycle at the end of January when the Treasury Department took “extraordinary measures” to avoid hitting the ceiling and defaulting on its debt. Those measures formed a temporary stopgap: They didn’t solve the debt ceiling problem, but they did give Congress a few more months to choose how to address the issue by redirecting monies and assets which fund retirement programs for federal workers.
Recently, the debt ceiling issue has come roaring back to the headlines. The effects of those extraordinary measures was predicted to hold off the crisis until some time between July and September. That prediction has recently been changed to warn the nation could default on its obligations as early as June. With little sign of a debt ceiling resolution coming from Congress any time soon. This situation has caused Wall Street investors to become jittery, and that’s where your personal finances come in.
The question then becomes, what can you do to prepare your finances for the end result of this debt ceiling crisis, whether it’s raised or not?
I talk about diversification a lot because it’s important to have a balanced portfolio. But diversification isn’t just about making sure you have a broad spectrum of assets in your portfolio. You also want a diversity of perspectives in the people who are helping you choose those assets. If you only take advice from a single money manager, you risk your whole portfolio if that perspective happens to be wrong.
This is why, at Asset Preservation Wealth & Tax, we use multiple money managers when making investment decisions. We want to bring multiple points of view to the table. We want a variety of people who will react differently to given economic situations and events. That helps us stay balanced, which reduces what we feel is one of the biggest risks in any portfolio: investing with an overly-limited perspective. As we are already seeing increased market volatility in reaction to the debt ceiling crisis, it makes sense to ensure our portfolios are properly diversified to avoid overexposure to any one potentially volatile asset class.
Understand Your Real Risk Tolerance
Whenever markets become volatile, there’s a strong temptation to do exactly the wrong things at exactly the wrong times. Investments that performed well for you previously may drop suddenly and sharply. That can easily cause some investors to panic and divest those assets because they fear losing even more money.
I go more in depth into the rationale behind that tendency in my recent blog about behavioral finance, but in short, many investors end up selling their assets for less than they paid for them. Selling at a loss is a terrible way to make money!
This is why it’s very important to truly understand your risk tolerance. Don’t make the common mistake of assuming you’re comfortable with higher-risk assets just because those assets are performing well when you invest. You can’t be accurate about your comfort level if you incorrectly assess how risky those assets are.
Think about how you will feel if those assets lose value after you buy them. Will you still be OK with the risk you took on? Will you stay invested so you can take advantage of any future gains, or will you dump them in a panic, losing money on the transaction?
In other words, if you decide you like skydiving, you don’t want to discover you’re afraid of falling after you jump out of a perfectly-good airplane: You want to know you’re risk-averse before you fall!
As a way to self-check your risk tolerance, think about how your comfort level with risk fluctuates. A good goalpost is that your risk tolerance changes slowly over time. For example, early in your working life, taking on higher risk can pay off through higher gains.
Higher risk is easier to absorb in the early stages of saving because you won’t need to access that money for many years, which gives those investments time to recover should their value drop. As you get closer to retirement, it’s generally appropriate to dial back that risk. This slow alteration of your risk tolerance is normal and sound financial wisdom.
On the other hand, if you tend to be aggressive when the market is up, then quickly swing to feeling more risk-averse when the market drops, that could be a sign that your risk self-assessment needs adjustment. If you find yourself going from aggressive to conservative virtually overnight, you’re no longer strategizing risk; you’re timing the market.
Bank of America conducted a study which examined market performance from 1930 to 2020 to determine the wisdom of timing the market versus staying invested long term, given that predicting the market with 100% accuracy is impossible. The results showed that an investor who tried to time the market and missed the 10 best-performing days each decade, would have netted a 28% return on their investment. However, if they’d stayed invested through positive and negative market swings, their return on investment would have been a staggering 17,715%!
This starkly illustrates why it’s a very good idea to determine your risk tolerance, and to be sure your perceived comfort level with risk is not itself volatile. As I frequently tell clients, time in the market is more important than timing the market.
If our elected officials were to allow the United States to hit the debt ceiling, the results could well be disastrous, at least for the government on a global scale. Just as you have a credit rating, so too does the government, and if it were to default on its debts, that credit rating would suffer. This would make borrowing money more expensive not only for the government, but for businesses and individuals as well. Shockwaves could rock the financial markets, and if we weren’t already in a recession when it happened, hitting the debt ceiling could be the tipping point.
Of some comfort is the fact that we’ve been here before. The United States hit the debt ceiling in 2011. While the country avoided default, it still had a significant impact on markets, retirement savings and caused the Federal Government’s credit rating to drop for the first time in history. However, the country recovered; as with most things, the bad times did not last forever, and the subsequent decade saw one of the best market performance records in history.
In short, don’t panic. Check with your trusted financial advisor to make sure your portfolio is set up to weather potential storms. If you haven’t already done so, choose an investment strategy and then stick with it. If you feel rising panic and a strong urge to divest to “cut your losses,” consult with your financial planner first. Let your money managers prepare for specific risk so you don’t risk losing ground by reacting rashly.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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