Financial advisers and other experts say the full impact of the headline-grabbing bill may not be known for weeks or months, especially with so many more details of the legislation passed yesterday still being worked out and interpreted. But many think it’s going to force many folks to rethink everything from their portfolio allocations to their tax movements. Two areas of concern already have emerged: Social Security and Medicare beneficiaries have been spared so far, for example, but experts say seniors could still be hit in phase two of the deficit-reduction plan. Investors, meanwhile, worry that the deal will further drag down the sputtering economy — and take the stock and bond markets with it. From the standpoint of economic growth, the cuts are “one more thing going in the wrong direction,” says Chad Stone, the chief economist for the Center on Budget and Policy Priorities.
News Hub: Debt Deal – What’s Happens Next?
Now that the debt deal is done, Jerry Seib looks at what comes next, including the selection over the next two weeks of a special committee of six Democrats and six Republicans, who will determine a further $1.5 trillion in spending cuts by Nov. 23.
.In general, most pros recommend against any knee-jerk moves. Still, there are certain areas that are more likely to be impacted than others. Below are seven — from retirement planning to the fate of the dollar — that could require new strategies in the months ahead. These are by no means definitive, but think of them as a starting point for how to adjust your portfolio and finances.
Retirement planning. It’s not what the bill did — it’s what it didn’t do. Namely, it failed to extend the payroll tax cut passed in 2010, “which means unless separate legislation is enacted, workers will see their paychecks shrink in January when they have to start paying an additional tax of 2% on their earnings,” says James Horney, vice president of federal fiscal policy for the Center on Budget and Policy Priorities. (The cut was a one-year relief measure, so take-home pay ought to be about where it was a year ago.) In recent times, strapped workers have made up for their income shortfalls by taking out 401(k) loans: Vanguard reported a 14% uptick in 401(k) loans from 2009 to 2010; T.Rowe Price an 11% increase. And it might be also be tempting to make up for that cash shortfall by contributing less to your 401(k), but that can be a big mistake, says Michael Wall, founder of Wall Financial Group in Altoona, Penn. “It’s a compounding effect, so not saving that extra money can have a big impact on your total retirement savings,” he says.
Retirement income. For retirees who rely on municipal bonds for income, the cuts are a cause for concern. Any decrease in federal spending will mean less aid for states and local government — making many already-weak states even more vulnerable to downgrades, budget deficits and layoffs, says Matt Fabian, managing director of Municipal Market Advisors, an independent research group. And while the U.S. dodged a default on its debt, a downgrade by the major credit rating agencies hasn’t been ruled out. Such a move would likely lead to lower ratings for several states that are dependent on the federal government, says Chris Ryon, managing director for fund company Thornburg Investment Management. Investors would be smart to spread their bets across all kinds of municipal bonds, focusing less on state general obligation bonds, which are more dependent on federal aid, and more on essential service revenue bonds, or those funded by revenue from water, sewer and electric services, he says.
.The dollar. The resolution of the debt crisis brought an immediate rally in the dollar, with the U.S. dollar index rising 0.49% on Monday as a deal seemed imminent, but the rally was already slowing down by Tuesday morning, and the longer-term picture for the greenback isn’t so great. For one thing, the deal doesn’t appear likely to produce the kinds of savings that Standard & Poor’s had said were necessary to avoid a downgrade, according to a report by Camilla Sutton, the chief currency strategist for Scotiabank. The work that remains to be done on the debt problem combined with weak economic growth suggests the dollar will continue to weaken through the end of the year, Sutton writes. That’s bad news for travelers, but it could help some investors, says Kate Warne, U.S. investment strategist at Edward Jones. Investors who own stocks or funds in other currencies will see the dollar value of those investments rise if the dollar falls against other currencies, Warne says.
Student loans. The deal is good news for undergrads — they can still get subsidized federal student loans, which allow them to pay no interest on their loans as long as they’re currently enrolled in school more than half-time — but not such good news for grad students, who can no longer get them as of July 1, 2012. It also went a long way towards funding the shortfall of the Pell Grant program, which helps low- and moderate-income students. But “we’re not out of the woods yet,” says Pauline Abernathy, the vice president of the Institute for College Access and Success. In fact, the Pell Grant program is still facing a $1.3 billion deficit, she says. To make up for this, Congress may consider changing eligibility for the grants from up to 18 semesters to just 12 semesters, or by increasing enrollment requirements, says Mark Kantrowitz, publisher of FastWeb.com and FinAid.org.
Mortgages and housing. The passage of the debt deal is likely to keep mortgage rates low for now, says Keith Gumbinger, vice president HSH.com, a mortgage information website. But prospective homebuyers could soon find themselves with fewer incentives once the details of the debt deal are ironed out. Lawmakers have been debating a simpler tax system with lower tax rates and fewer tax breaks that could include reducing the generous mortgage tax deduction as part of the long-term spending cuts that must be agreed on this fall, says Brian Gardner, senior vice president at Keefe, Bruyette & Woods. The takeaway for prospective homebuyers: Act soon. “If you’re kind of thinking about it of course it’s always better to move forward more quickly,” says Gumbinger. “Right now you’re working in known market conditions rather than tomorrow’s unknown market conditions.”
Your portfolio. Wherever the actual cuts come from, the debt deal is likely to be a drag on the economy: Most estimates suggest that the deal will reduce economic growth by about one-tenth of one percent. Investing pros say the deal itself doesn’t radically change their asset-allocation recommendations, but reinforces the need to diversify your portfolio with international stocks and debt. “In a world where growth seems challenged everywhere, we still think diversification is a good thing to do,” says Warne, who recommends investors have at least 30% of their stock portfolio in foreign markets, mostly developed, with about a 5% allocation to emerging markets. Stephen Wood, chief market strategist for Russell Investments, urges even more weighting to international: Investors should match their portfolios to the overall makeup of the global economy, which would mean keeping only about 45% of assets here at home.
Health care. Medicare will be protected in the first round of the debt deal, but it looks more vulnerable in phase two, in which a special joint committee is tasked with finding at least $1.2 trillion in additional savings. If the committee cannot do this, Medicare provider payments are scheduled to be automatically cut by up to 2%. If this happens, consumers may find that some doctors will stop accepting Medicare patients and that hospitals will close units, says Mary Johnson, a senior policy analyst for the Senior Citizen’s League, a non-profit seniors rights advocate. And in looking for savings, the committee may consider plans like lifting the Medicare eligibility age from 65 to 67 or increasing co-pay amounts, says Joe Baker, president of the Medicare Rights Center.