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Debt Default and Your Portfolio

My last post was a recommendation to ignore the headline news. I must admit it certainly has been difficult to ignore the news recently as it seems all we are hearing about is the debt ceiling and deficits. The President even urged citizens to contact their representatives in Congress to ‘weigh in’ on the debate.

There have been many articles about the chances of a US default on its obligations and what a US default would mean to the economy and investors. Suffice to say: no one really knows. First, will we even have a default? While no one knows for sure, the markets are behaving as if they do not believe it is going to happen. While the markets have been down the past two days, I do not think anyone would consider the past two days as ‘highly volatile’. Especially compared to what we saw in 2008. While my own crystal ball is highly cloudy, I suspect our leaders will reach some agreement by August 2nd.

But, what if no agreement is reached and the US does go into default? Again, no one knows exactly how the markets are going to react. While the prevailing wisdom is that the market reaction would be negative, there may be enough folks who think it is a good think that we go into default. (The thinking is that a failure to reach an agreement to raise the debt ceiling by next week will force the government to spend less. Less spending is what a lot of folks want to see.) Remember: the President had set last Friday as a ‘deadline’ to reach a deal and the Speaker of the House John Boehner wanted a deal by Sunday at 4pm before the Asian markets opened for business. Both of those deadlines passed without a deal and the world did not come to an end. So, it is truly impossible to say how the markets will react.

Many individual investors are of course thinking about what all of this means for their own savings and investments. If you have a well-thought out investment plan which includes an evaluation of your own ability, willingness, and need to take risk, then none of issues being discussed should really matter. A proper investment plan takes into consideration that there will be ups and downs in the market and from time-to-time there may be severe market reactions to unexpected news. Then one should base their allocation to risky assets (i.e. stocks) on this evaluation of risk. So, the question investors should be asking is if they have a well-thought investment plan that anticipates all market conditions, both stable and volatile? Trying to guess what the market will do in one month, one week, or even one day is a fool’s game.

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