WASHINGTON (Reuters) - Now what? If you’re confused by the debt deal and what it means for your own wallet, you’re not alone.
The fine print in the deal raises more questions than it answers. Almost all discretionary federal spending will face some cuts over the next 10 years, with defense spending taking a comparatively heavy hit. The bill calls for $917 billion in initial cuts over 10 years, with roughly $350 billion of that in defense and security spending.
Perhaps more significantly, the deal sets up a bipartisan 12-member congressional committee to find another $1.5 trillion in cuts. That group’s menu is wide open and could include Social Security reductions or tax increases. If that committee fails to come up with at least $1.2 trillion in savings - or Congress doesn’t approve its recommendations by December 23 - automated cuts begin to get triggered. Those cuts would be deep, hitting Medicare and the military but sparing Social Security, Medicaid and a handful of other programs.
So, everything’s been decided and nothing’s been resolved. That doesn’t mean that individual savers and investors shouldn’t continue to try and protect themselves from the fallout. Here are some moves to make or avoid now.
* Play defense on defense stocks, and all government contractors. “Stock investors who have companies that depend on government financing should monitor their holdings carefully,” said Charles Rotblut of the American Association of Individual Investors. Defense contractors are likely to lose business as these cuts work their way through the system, but so will other government contractors, and state contractors too, as already recession-pinched states will lose some federal funding.
“Infrastructure is at particular risk, because it’s going to be a lot harder for states to work on bridges, roads and highways,” Rotblut said.
He suggested that investors dig into the 10K annual reports of companies to see how dependent they are on government work.
* Relax a little about your bonds. “Bonds are not as scary as before,” said Don Martin of Mayflower Capital in Los Altos, California. Conventional wisdom still holds that long-term bonds will take a hit as interest rates rise, but this debt deal may defer that day for a number of reasons. With Congress making good on U.S. obligations, that diminishes the possibility of a ratings downgrade pushing Treasury rates up. And the bill’s budget cuts, which mainly don’t go into effect until 2013 at the earliest, could crimp economic growth, delaying the rise of interest rates.
“The economy has hit stall speed and is beginning to slip back into a recession, so with the reduction of government stimulus caused by austerity this means that stocks will go down and bonds will go up,” said Martin. Investors still may want to move their bond holdings to a less-concentrated, shorter-term or more cautious approach, but there’s less need to panic about them.
* Put your student loans on autopilot. The debt bill will eliminate the rebate that education borrowers get when they make a year’s worth of loan payments on time. But they still may be able to get an interest-rate discount if they arrange to make their payments automatically through a bank account debit - that’s worth doing.
Many graduate students will have to pay more for loans, as this deal eliminates the federal subsidies that paid interest costs on some of their loans while they were in school. Grad students may find it worthwhile to pay the interest themselves while they are in school, if they can, to avoid those costs compounding until after they graduate.
* Defer your Social Security benefits. That’s been bedrock retirement advice for a while, but that new bipartisan congressional committee could make it more true than before. Here’s why: Every year that you defer starting your Social Security retirement benefits, they rise by almost 8 percent. But there’s a lot of talk about tinkering with the cost-of -living adjustments that apply to benefits once they’ve started flowing, and the bipartisan committee may do that in their next round of cuts.
If Congress shifts to a different inflation measure that moves up less quickly than the currently-used Consumer Price Index, it would limit upward adjustments on benefits. Starting benefits early means you relinquish that 8 percent a year increase and, should the COLA be nipped, start giving up buying power sooner. “That would be a significant problem for clients who rely on Social Security,” said Mark Berg, of Timothy Financial Counsel, a fee-only financial planning firm. “We would encourage a wait approach on Social Security if the client can afford it.”
* Expect more tumult, so, as always, save more. “If we have learned anything from this crisis, it’s not to depend on the government for anything,” said Bedda D‘Angelo, president of Fiduciary Solutions, a Durham, North Carolina, financial -planning firm. “Entitlements change with the wind. Since pensions are being phased out too, the only sane thing to do is max out your tax-deferred retirement savings accounts.”
Advisers have been telling their clients to get defensive for some time: Investors who pay down their debts, move more of their bond money to shorter-term instruments and their stock money to defensive dividend-earning stocks will be better prepared for whatever the government throws at them next, suggested money manager Daniel Romero, of Romery & Levin Wealth Management in Santa Ana, California.
“This is the fourth or fifth Armageddon situation that’s come across our desk in recent years,” commented Romero, who’s had his clients building reserves, paying down debts and diversifying broadly into commodities, Japanese stocks, natural resources stocks and more. “Just put yourself in a situation where it won’t affect you so much.” At least until the next crisis.
Editing by Beth Gladstone