401k’s not prepared for the coming storm
Hurricane Sandy surprised people and severely damaged the local infrastructure in the New York-New Jersey area.
Could the coming “Fiscal Cliff” hurricane damage your 401k?
It’s going to happen. Even if Congress solves the problem at the 11th hour the problem is that the cliff hanging suspense at the end could cause a market panic of significant proportions. Investors are used to the idea that they will always get bailed out by the Federal Reserve or Congress (the Greenspan-Bernanke Put option). But now that rates are at zero the Fed can’t help and Congress will be tied up in debates. This could be quite a shock when investors realize they are adults, not children getting a subsidy from their parents (the Federal Reserve). When investors realize they have overpayed for bubble stocks and the Fiscal Cliff has arrived then the situation will not be pretty. The only question is how severe will the effect be on each individual’s finances.
The Fiscal Cliff includes substantial tax increases that will hurt high income people. These people do a disproportionate amount of shopping so when they cut back on purchases to pay income taxes they will cause a recession. Government expenditures will be cut drastically resulting in layoffs of people who are used to guaranteed employment. These people will reduce purchases of goods and services, throwing the economy into a recession.
The net effect will be a 4% reduction in GNP from positive 2% to negative 2%. This will result in less tax revenue and more spending on unemployment, etc. with the result that the Federal deficit will be even higher. In conventional Keynesian economics there is no known cure for the long term Soft Depression that we are experiencing and the Fiscal Cliff will only make things worse.
If there is such a thing a Global Warming creating more intense storms that damage the economy then perhaps economists will claim there is Global Fiscal Cliff Warming that creates dangerous economic storms.
To prepare for the Fiscal Cliff one should sell off risky investments and switch to low risk investment grade bonds such as Treasuries. This is risky since rates are very low so if the economy should improve that would trigger inflation alarm bells which would make interest rates go up and bond prices go down. One may need to invest in near cash things like the two year Treasury Note to avoid the risk of inflation and avoid the risk that risk assets may crash during the coming “Fiscal Cliff” hurricane.
One should be aware that high risk investments like companies with too much debt, with shaky earnings, with non-proprietary products, with speculative unreliable product lines are risky and could crash harder than the average stock. If you insist on owning stocks during a bear market then please study the principles of Buffett style investing in companies that have below average risk. It may be safer and simpler to simply exit the equity market until after the “battle” between recessionary forces and stocks is over. Or consider buying a hedge fund that employs Long-Short strategies.
I have written an article “Six things you must know about 401k risks”.
Investors should seek independent financial advice.