The Fiscal Cliff
You have likely been hearing a lot about the "fiscal cliff" and in case you were feeling concerned, we wanted to share a few thoughts.
The fiscal cliff refers to the potential negative impact on the economy due to scheduled tax law changes combined with spending cuts required by the debt ceiling compromise in 2011. Higher taxes and reduced government spending would significantly cut the deficit, but could also cause a major slowdown at a time when the economy is already on shaky ground.
The fiscal cliff can be largely avoided if Congress can agree on limited tax increases and cuts in spending. Based on the last few years, it is hard to imagine the two opposing parties agreeing on anything. However, compromise might be possible now that the election is behind us (and neither side wants to take blame).
No matter what Congress decides to do, we can assume tax rates will be going up. Congressional inaction will result in the expiration of the Bush tax cuts along with the tax increases associated with the new healthcare legislation. Even with a compromise, tax hikes will certainly be a reality and we can expect ordinary tax rates to increase for at least the highest income earners, higher taxes to apply to investment income, and capital gain rates to bump up for all.
So, what should you do? As always, we believe you should stay the course. At this point, the market already reflects the possibility of a fiscal cliff. And, it is just as likely that the market will move up if there is some kind of agreement as it is that the market will fall with an extended gridlock. Without a crystal ball, staying invested, rebalancing and harvesting tax losses (and in some circumstances gains) is the best strategy for the long term.
When we rebalance your portfolio, we are essentially selling high (reducing holdings that have increased in value) and buying low (buying positions that are "bargains"). This is the opposite of what emotional individual investors do. Seasoned investors know that rebalancing adds value over time.
With tax rates increasing, our tax saving strategies are more important than ever. We are able to lower your tax bill as part of everything we do. We harvest tax losses on an ongoing basis, choose high cost tax lots on sales, and prioritize location optimization (deferring taxes on income-producing investments in IRA accounts and changing ordinary income into capital gains by holding appreciating assets in taxable accounts).
Diversification and cutting taxes will result in better long-term returns than trying to predict the market. The potential fiscal cliff is just a bump in the road. Stay calm, try to ignore media sensationalism, and remember that the market always fluctuates. It is that volatility that provides greater returns over time. Please know that we are here to answer any questions or concerns you might have.
The E&G Team