What is the Fiscal Cliff?
The Fiscal Cliff is a term that is used to describe a series of economic events that are set to occur at about the same time. I have broadly grouped these events into the following three categories:
- The expiration of the Bush tax cuts. It’s important to understand that normally a set of tax changes that will increase the federal deficit must be offset by a reduction in spending so the change ends up being budget neutral. By setting a ten year expiration date for the Bush tax cuts, they were able to bypass this rule. The Bush tax cuts were set to expire on 1/1/11, but were extended for two years under the 2010 Tax Act.
- Enactment of spending cuts under the Budget Control Act of 2011. Congress has the sole power to borrow money on the credit of the United States, and must approve increases in the total amount of debt that the United States can issue. This limit is referred to as the debt ceiling. In 2011 as we neared this ceiling, Congress agreed to raise the ceiling, but to keep things balanced, required a series of spending cuts that would begin in 2013. These spending cuts are set to kick in, contributing to the phenomenon referred to as the fiscal cliff.
- Nearing the debt ceiling again. We are once again reaching the allowable limit of U.S. debt. This is being used a political bargaining tool in negotiations on how to deal with the fiscal cliff. What can you do about it? Check out this article Here's What You Can Do About the Debt Ceiling for some specific political actions you can take.
Making Investment Decisions Based on the Fiscal Cliff
In recent years our politicians and economy have provided an astonishing number of excuses to use if you simply want an excuse to avoid making a decision. Readers and clients have provided me the following reasons for putting off planning and investment decisions:
- The great global recession of 2008/2009
- The US debt downgrade in 2011
- The 2011 fiscal cliff scenario
- The 2012 election
- Now, the 2012 fiscal cliff scenario
In my conversations and emails people continuously say “I am going to wait until (insert excuse here) to make a decision.”
You know what? We never know what is going to happen!
In 2007 when you were safely investing in equities, did you expect calamity to hit? No.
In 2009 when the market had hit bottom, did you expect extraordinary returns and dive in so you could participate? No.
The best investment decision you can make is to build a long term plan based on your personal goals and then stick with it.
Let’s take the looming fiscal cliff now as an example. Suppose no resolution occurs and the full tax cuts and budget cuts are implemented. Then suppose that heads us toward a recession as many economists think it would. Does that mean the market will tank? It might. It might tank, then rebound. If it does, will you have a sudden change of heart and get in at the bottom? Not likely. You’ll be waiting for something else at that point.
What if the fiscal cliff is amicably resolved. Does that mean the market will go up. It might. Then what do you do? Invest at a higher price? Or wait for something else?
Safely Losing Money
Many people are safely losing money while they wait. How does that happen? They might be earning 2% in a certificate of deposit. After taxes they get to keep 60 to 75 cents of every dollar of interest they earn. Meanwhile inflation is 2 – 3%. Like erosion, their savings are slowly losing purchasing power.
This article, Surprising Choices in the Search for Safety Near-Certain Loss of Purchasing Power versus Short-Term Volatility? does a great job of explaining the current investment dilemma that we face.
Now, don’t get me wrong. I am not saying to go out and dump a bunch of money in the stock market. I am saying you should not let current events deter your from creating a plan, implementing it, and sticking with it.