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 .
There’s no need for panic. Congress is likely to reduce the “cliff” to a smaller bump, though it probably won’t happen until after the election. 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. (Keep in mind that while diversification can reduce the impact of market volatility, it cannot guarantee profits or protect against losses.) You may need to “rebalance” your portfolio to ensure that it’s still aligned with your goals, risk tolerance and time horizon, despite the impact of volatility.
Now, let’s turn to taxes. Even if taxes on income, capital gains and dividends do rise, they will still be 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 other employer-sponsored retirement plan, and any education savings accounts you may have, such as a 529 plan.
• 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 and may not be appropriate if you don’t have money readily available to pay the taxes.)
• 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, and possibly state and local taxes as well.
Not all these choices will be suitable for your situation so 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 Jim Talley, financial advisor at Edward Jones, 2703 Beaver Ave., 279-4179.