What Do We Do Now?

Let’s get up to speed first

Last week, Congress & the White House came to a zero-hour agreement to raise the debt ceiling, covering the nation’s short term debt needs.  While there were some cuts made in future spending, the greater challenge of creating long term, meaningful solutions was left to a Congressional committee, charged with presenting a deficit reduction bill to Congress by Thanksgiving.
Friday evening Standard & Poor’s, an agency that rates the quality of various securities, debt obligations, governments and other entities reduced its rating of the U.S. government’s long term debt from its highest rating tier, AAA to the second highest rating tier, AA+.  There are varying opinions as to the validity of this decision, whether it was warranted or not and what it truly means for the economy, both in the U.S. and abroad over the long term.  Standard & Poor’s ultimately felt the current plan for reducing the debt is far from sufficient and that it needs to see more action from the government before improving their outlook.  As of this writing, the other ratings agencies have held the United States’ AAA status, but have warned that they, too, are concerned.

The world markets responded to these events in a very negative fashion on Monday, speeding up some already brisk downward moves from the week prior due to continued tension in Europe and slower than expected growth in various sectors here in the U.S.  Tuesday, the Fed released a statement confirming that interest rates will likely stay put for the foreseeable future.  Along with some positive corporate earnings, this news drove the market up nearly 4% and the Nasdaq up more than 5% on an extremely volatile trading day.

We continue to believe that the best defense in any market is to have a broadly diversified, low cost portfolio that is thoughtfully rebalanced to track with our client’s long term goals and tolerance for risk.  That said, we wanted to take this opportunity to provide our view on some commonly asked questions surrounding recent events. 

Are my cash & short-term bond funds safe?

In a word, yes. The money market funds we utilize are of very high quality and will continue to provide safety and security for our clients’ cash reserves.  Much the same, the remainder of the fixed income side of the portfolios, while subject to market fluctuation, are all short term, high quality bond funds.  Using these tools helps protect our clients from a number of factors.  For example, the debt downgrade impacts long term U.S. debt, but its short term rating has remained unchanged, meaning the impact of the S&P downgrade is likely to be minimal.

What can we do?

For most of us, the option to pull out of the market is the worst possible scenario, as can be illustrated by the late afternoon rally on Tuesday.  We will take action by continuing to look for opportunities to buy low and sell high as the volatility provides rebalancing opportunities.  Sticking with our long term discipline served us very well in 2008 and 2009 as the purchases we made during the worst of times have produced the strongest returns since.

While this sometimes feels like a “do nothing” response, it isn’t.  The truth of the matter is, to quote author and financial planner, Carl Richards, “The time to prepare for a crisis is long before you find yourself in one.  It’s not a good idea to figure out how a parachute works after you jump out of the plane. Financial plans and asset allocation models are built for the long term. Large fluctuations in market value are expected and are necessary as the downswings provide the buying opportunities that we’ll take advantage of in future upswings.  How one responds to these temporary fluctuations over a lifetime of investing is what really tests us as investors.

This is the first time the U.S. debt rating has been downgraded.  Is this time different?

No. While the look and feel of this crisis has different characteristics of the prior crisis, which had a different look and feel than the one prior to that, these issues, while incredibly painful and emotional, tend to appear and behave like most financial crises in hindsight.  They are part of the natural economic cycle of booms and busts, the constant battle between fear & greed.
Corporations around the world continue to collectively be healthier than they’ve been in quite some time.  Many are sitting on larger than usual cash reserves and earnings have remained strong overall.  Famed economist Burton Malkiel recently said, “Panic selling of U.S. common stocks will prove to be a very inappropriate response...no one can tell you when the stock market will end its decline, but there are some things we do know.  Investors who have sold out their stocks at times when there have been very large declines in the market have invariably been wrong.”

Who should I be reading? What should I focus on?

The best answer is that you should be reading your favorite books and magazines, and focusing on that which you can control and enjoy.  If this current economic situation fits that bill, below are some excellent articles that help breakdown what has occurred of late and a variety of responses.

Resisting The Urge to Run Away - Ron Lieber, New York Times, August 5, 2011

Your Neglected Stock Market Backup Plan - Carl Richards, New York Times, August 8, 2011

Don’t Panic About the Stock Market – Burton Malkiel, The Wall Street Journal, August 8, 2011

This crisis will come and this crisis will go. The same goes for the upswings. When they will occur is something that no one can tell you with any degree of accuracy, certainty or consistency. It’s tough to feel positive in the midst of so much uncertainty, but take solace knowing that if you stick to your disciplined plan and stay focused on long term results, you’re prepared.

Chip Workman, CFP®
cworkman@taaginc.com
http://www.taaginc.com/

Update from Washington

It was my hope this week to follow up my May blog on how changes in Social Security might impact you with an update on how the debt ceiling and budget agreement in Washington would do the same.

One small problem, I was relying on Washington to actually have a deal in place by today.  Serves me right, I suppose.  Here we sit Wednesday morning knowing just as little, if not less, than ever.  It’s still my humble opinion that some kind of deal will get done soon, but the details from there are anyone’s guess.

I’ll instead attempt to introduce some more of the latest proposals getting support in regards to this legislation.  I hesitate to add to the load of information (and misinformation) on this topic.  But, as these ideas get kicked around the floor of Congress, the nightly news and the internet, I think it’s important to provide a basic, centered background on what they might mean for you.

Social Security Cost of Living Adjustments

One targeted way to help slow the growing costs of Social Security is to change how it accounts for inflation.  Currently, annual adjustments are tied to the consumer price index, or CPI.  For example, with traditional CPI, if the cost of beef rises, the index rises accordingly.  The push is to change this in favor of what’s known as a “chained” consumer index.  In this case, if the price of beef rises, an adjustment is made to account for those that would simply buy cheaper cuts or choose another source of protein.  This would lower the average rise in social security benefits from year to year.  It is unclear how much support this has and it would not be sufficient to sustain Social Security for any length of time, but it is a term you might hear in the coming days and weeks. 

Social Security Payroll Tax

Employees have been enjoying a 2% cut in the Social Security payroll tax over the last year and a half.  While it seems counterintuitive when trying to determine how to get more money into the program, there is talk of maintaining that reduction and extending it to employers as a form of additional stimulus for the economy.  Of course, this would likely be tied into the other Bush era tax cuts that are currently extended through 2012, setting up another major clash on tax rules not too far down the road.

Medicare Adjustments

Medicare is an area where details are few and far between as politicians remain reticent to tackle Washington’s most challenging program.  The most commonly advocated tax reform measure tied to Medicare is limiting the current $1.1 million mortgage interest deduction ceiling to $500,000 and restricting the deduction solely to primary residences.  This would be another drop in the bucket, but seems to have a fair amount of support. 

In other words, the unknown continues to be the unknown.  The good news is that most of the changes being considered are slow moving and will take 10-20 years to fully come into play.  It will take much of the burden off anyone currently receiving benefits and give those who hope to in the future time to plan and adjust accordingly.

The best offense is still a good defense.  Having a broadly diversified portfolio capable of responding to different market pressures and providing for what you need in the short term, maintaining spending patterns that are within your means, and combating future health care costs by eating well and staying fit are the best tools to combat whatever comes down the pike.  The only other recommendations I have would be to ignore the noise as much as possible until firmer details present themselves and, if you feel strongly about it, put that venting to use by sending an e-mail to your representatives.

It is my sincere hope to have an actual update on what was passed rather than what might be passed in the near future and how the rising debt ceiling and budget agreement impact you. 

Have a great week!

Chip Workman, CFP®

cworkman@taaginc.com

www.taaginc.com