As an investor, you can sometimes feel you’re at the mercy of forces beyond your control. This may be especially true today, when the Federal Reserve has warned of an approaching “fiscal cliff.” What can you do in the face of such a dire prediction?
You need to understand what led to the Fed’s remarks. Some $1.2 trillion in spending cuts are scheduled to begin in 2013 while, simultaneously, the Bush-era tax cuts are set to expire. This combination of spending cuts and higher taxes could take some $600 billion out of the economy, leading to a possible recession — and maybe something much worse.
Still, there’s no need for panic. Despite its political infighting, Congress is likely to reduce the “cliff” to a smaller bump. But as an investor, you may need to be prepared for two significant events: market volatility, at least in the short term and higher taxes, probably for the foreseeable future.
To combat market volatility, you need to own a broadly diversified portfolio that can handle “bumps,” “cliffs” and other rugged investment terrain. This means you’ll need a mix of stocks, bonds and other securities that are suitable for your needs. (While diversification can reduce the impact of market volatility, it cannot guarantee profits or protect against losses.) You may also need to “rebalance” your portfolio to ensure that it’s still aligned with your goals.
Now, let’s turn to taxes. Even if taxes on income, capital gains and dividends do rise, they will still, in all likelihood, be much lower than they’ve been at various points in the past. Nonetheless, you may want to consider a variety of steps, including the following:
• Take advantage of tax-deferred vehicles. Contribute as much as possible to your traditional IRA, your 401(k) or retirement plan and any education savings accounts.
• Consider converting your traditional IRA to a Roth IRA. A Roth IRA provides tax-free earnings, provided you don’t start taking withdrawals until you’re 59½ and you’ve had your account for at least five years. (Be aware, though, that this conversion is taxable.)
• Consider municipal bonds. If you’re in one of the upper tax brackets, you may benefit from investing in “munis,” which pay interest that’s free of federal taxes.
Not all these choices will be suitable for your situation. Before taking action, you may want to consult with your tax and financial advisors. But give these options some thought because they may prove helpful in keeping your financial goals from going “over a cliff.”
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.
Information provided by Pat Franke, financial advisor, Edward Jones, 3520 Ingersoll, Des Moines, 255-9641.