Make no mistake, the fiscal cliff tax deal was the easy part. Yes, the American Tax Relief Act Of 2012 raised tax rates on couples earning more than $450,000 a year. But the politicians were mostly doling out tax goodies—continued low rates for 98% of Americans and special favors for the likes of GE, JPMorgan, Caterpillar, Nascar and Hollywood. Moreover, Congress’ last-minute antics were rewarded with a 4.6% jump in the S&P during the first week of the year.
What comes next, however, could be more nerve and market-rattling, and could permanently affect how (and how much) you need to save for retirement. Three deadlines loom: The federal debt ceiling must be raised by mid-to late February if the U.S. is to meet its obligations; on March 1, a two month delay in across-the-board sequester spending cuts runs out; and on March 27th, a continuing budget resolution funding the operations of the government expires. With Republicans warning they won’t increase the debt ceiling unless big spending cuts are made and President Barack Obama insisting he won’t bargain over that ceiling or make spending cuts without more tax revenue thrown in, the stage is set for some ugly—and possibly significant—action.
“How we solve our nation’s debt and deficit is the seminal investment, economic and political issue of this decade,’’ says Vanguard Group Chief Economist Joseph Davis. He adds that government policies (both in the U.S. and Europe) haven’t been so important to the markets since a determined Federal Reserve Chairman Paul Volcker helped break the back of stagflation more than three decades ago. (Hey, fellow aging boomers—kind of makes you nostalgic, doesn’t it, like a Mick Jagger tour? Remember 18% certificate of deposit rates and those wild and crazy savings and loans?)
So what does this mean for your retirement and finances? It’s hard to predict short term market responses. For example, as Congress toys with defaulting on U.S. debt, risk adverse investors might flee equities, perversely raising the demand (and lowering the interest rate) on the Treasuries Uncle Sam is threatening to default on, Davis points out. So you can’t predict, but you can prepare–and in two main ways. First, you can protect yourself from the short-term havoc a dysfunctional Washington could create and second, you can try to anticipate likely changes in federal policy when our warring leaders finally cut some sort of a deficit reduction deal.
Here are five steps to take now:
1. Move funds you need short term into cash or money markets. “We had been advising a three to six month emergency fund, but in times of volatility and market instability, you may want to go to six to nine months,’’ says Judith Ward a senior financial planner and vice president of T. Rowe Price Investment Services. (I know. There’s a real cost these days to holding cash. So for an alternative approach to ensuring liquidity, see William Baldwin’s Investment Strategies column here.)
Read More at forbes.com . By Janet Novack.