The stock market took it on the chin the last couple weeks, reflecting several intertwined post-election themes: Bets on a Romney win were likely unwound, investors are trading in and out of perceived sector winners and losers, while many investors are also bracing for coming tax increases. Financial, energy and technology stocks have been particularly hard-hit — driven by the regulatory landscape.
Ideally, what does not happen is a repeat of August 2011, when markets went into riot mode during the debt-ceiling debacle and subsequent downgrade of US debt by Standard & Poor’s. Unfortunately, it is a distinct possibility. I do expect the markets — more likely on the stock side — to play an important role as a messenger to our politicians.
Fiscal cliff in sharp focus
Dominating the conversation as we wind out the year is the “fiscal cliff.” At this stage, there are many possibilities:
1. Fall off the cliff entirely;
2. Short-term deal with only partial Bush tax-cut expiration and delays or deals on other components;
3. Grand bargain;
4. Full kick-the-can;
5. Kick-the-can, but strike outline of eventual deal as “down payment.”
It’s our perspective that the full kick-the-can option may be even less favorable for the market and economy than falling off the cliff altogether. Frankly, can-kicking has become a sport played too often in Washington. Look, we know what the problems are — waiting for some period of months won’t provide new solutions. We have a model for the perils of perpetual can-kicking and it’s the debacle that is the Eurozone.
I do see some coiled springs in the economy that could be loosened if/when a deal on the fiscal cliff comes to fruition. We’ve seen several phases of meaningful economic traction since the Great Recession ended in mid-2009, only to be squashed by often-political forces. Businesses have been hoarding a record amount of cash as they await more certainty on the tax/spending front. I do fear, however, that more market rioting may be needed before our politicians are forced into action.
What should you do?
Six easy steps:
1. The biggest decision you will make is how much to allocate to different investment categories (Equity, Fixed, Cash). Asset allocation is all about finding the mix of investments that is right for your situation. Goals, time horizon, and risk tolerance are some of the key factors that should be taken into consideration when allocating assets.
2. Diversify, diversify, diversify. Have assets spread across large and small cap growth, large and small cap value, International large cap growth and value, taxable and tax exempt bonds, and cash equivalents.
3. Lower your costs. Do not own expensive products like variable annuities or mutual funds, unless your retirement plan requires it. The costs of owning a fund is called the expense ratio. (This is distinct from the costs of buying a fund, which is the sales loads.) The expense ratio (paid by you every year!) represents the percentage of the fund’s assets that go purely toward the expense of running the fund. The expense ratio covers the investment advisory fee, the administrative costs, 12b-1 distribution fees, and other operating expenses. The nifty thing about the expense ratio is that it wraps all these various costs and expenses into one number so that you don’t have to do a lot of math. Currently the typical expense ratio for an actively managed mutual fund is about 1.5%, and that number has been going up lately.
4. Do not purchase long term bonds. Keep a maturity from 1-8 years. I can assure you, if you buy long term bonds in this low interest rate environment your principal will get hammered when Mr. Bernanke and the Fed inch up interest rates.
5. Maximize your contribution to your 401(k), 403(B), or IRA.
6. Meet with your advisor and talk about #1-4 above.
Stan Evans is a fee-based financial planner and registered investment advisor. He can be contacted at 740-682-0012; firstname.lastname@example.org. His website is www.stanevansfinancialplanning.com.