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Fiscal Cliff Rebalancing Your Portfolio For The Fiscal Cliff and How it Could Affect Your Net Worth


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A combination of expiring tax cuts and across-the-board government spending cuts scheduled to become effective Dec. 31, 2012. The idea behind the fiscal cliff was that if the federal government allowed these two events to proceed as planned, they would have a detrimental effect on an already shaky economy, perhaps sending it back into an official recession as it cut household incomes, increased unemployment rates and undermined consumer and investor confidence. At the same time, it was predicted that going over the fiscal cliff would significantly reduce the federal budget deficit.

Investopedia Says…
Who actually first uttered the words “fiscal cliff” is not clear. Some believe that it was first used by Goldman Sachs economist, Alec Phillips. Others credit Federal Reserve Chairman Ben Bernanke for taking the phrase mainstream in his remarks in front of Congress. Others credit Safir Ahmed, a reporter for the St. Louis Post-Dispatch, who in 1989 wrote a story detailing the state’s education funding and used the term “fiscal cliff.”

How The Fiscal Cliff Could Affect Your Net Worth

The fiscal Cliff is rapidly approaching, and the financial media is repeatedly warning that the $600 billion combination of tax increases and spending cuts will result in a sizable decrease in our disposable income starting next year. However, your income is not likely to be the only thing that will shrink if the fiscal cliff takes effect. The impact that it has on the economy will likely hit you in several other areas as well.

Tax Increases
We can start with the obvious. Experts estimate that the fiscal cliff will raise taxes by about $2,000 a year for the middle class and considerably more for the wealthy, but even poor people will pay more tax if we go over the edge. This is coupled with a reversion to the normal level of Social Security withholding by employers. For the past two years, Congress has allowed employers to withhold only 4.2% of employee wages for Social Security as a means of easing the cash flow of working taxpayers. This will end at the same time that taxes will rise. This reduction in cash flow may force many workers to cut back on their retirement plan contributions or other savings programs in order to make ends meet, which in turn will reduce the amount of liquid assets that they can accumulate.

Recessionary Impact
Many economists warn that the fiscal cliff could plunge the U.S. into another recession or at least a much steeper one. If this happens, then unemployment will rise again and property values will drop. This could translate into a few more years of stagnant home prices and possibly cause more homeowners to become underwater on their mortgages. Many home values have already declined substantially since the subprime meltdown, but this could make things worse for the foreseeable future.

Real estate won’t be the only sector affected. The economic impact from the Fiscal Cliff could also send the stock market into a tailspin, which could translate into declining balances in your 401(k), IRAs and other retirement accounts. This could also keep interest rates low for a while longer, which means that fixed-income investments will continue to offer tepid returns in the near future. The value of your investments is only part of this picture. Capital gains taxes will also increase next year if we go over the cliff, which means that you’ll be able to keep less of any gains that you realize. The top long-term capital gains rate will reset to about 20% (10% for taxpayers in the 15% tax bracket), which is 5% more than the current limit of 15%. Short-term gains will continue to be taxed as ordinary income, but these rates will also rise. Of course, smart investors already realize this is coming, and many of them along with professional traders and other major players in the markets will likely liquidate some of their holdings in anticipation of this, which could trigger a sell off in the markets in and of itself.

Estate Taxes
Unfortunately, income taxes aren’t the only thing that will rise if we go over the cliff. The estate of even a moderately wealthy taxpayer may be saddled with estate taxes that would not apply now. The amount of assets that can be passed tax-free to heirs now stands at $5.12 million per person, but this will shrink back to $1 million next year. All millionaires will therefore have to restructure their estate plans in many respects in order to stay current with the tax laws.

The Bottom Line
These are just some of the ways in which the Fiscal Cliff could take dollars out of your pockets. For more information on this pending issue, consult your financial advisor or your tax advisor.

Read more: http://www.investopedia.com/financial-edge/1212/how-the-fiscal-cliff-could-affect-your-net-worth.aspx#ixzz2GdmgHPDT

Rebalancing Your Portfolio For The Fiscal Cliff

The year-end represents an ideal time to rebalance your portfolio. Fears over the impact of the “fiscal cliff,” or the inability of politicians to come to an agreement regarding finding the right balance between government spending and revenue, are only complicating matters. Below are five recommendations to rebalance your portfolio that take into account shorter-term concerns as well as a more sensible strategy over the long haul.

Shift Your Dividend Focus
If the Bush-era tax cuts are not renewed, the dividend income tax rate is set to revert from 15% for qualified dividends to personal income tax rates. This could mean a tax on your dividends as high as 39.6% at the top income tax bracket. Already, companies are rushing to get dividend payments into 2012 and declare special payouts that push the payouts into the current year, instead of 2013.

An ideal rebalancing activity for investors is to shift dividend-paying stock holdings into non-taxable or tax-deferred accounts. This may not be possible in all instances, but moving from a taxable account to a Roth IRA, traditional IRA or related tax-efficient accounts could result in sizable savings.

Consider Buy-and-Hold
The expiration of the Bush-era tax cuts would also result in an increase in the capital gains tax from 15 to 20%. This isn’t as significant as increase in the dividend tax but it’s worth considering. Ideally, investors should re-emphasize a buy-and-hold strategy that emphasizes investing into solid, growing companies where capital gains taxes can be pushed well out into the future. Not selling a growing stock can lock up unrealized gains for many years and result in tax savings that add up over time.

Lower Your Bond Exposure
A number of highly-respected investors, including Hermes Chief Executive Saker Nusseibeh, are emphasizing stocks over bonds. “We’re done with the bond markets. People are beginning to talk about [that] there are certain assets which can grow with inflation, which can pay a dividend and have strong balance sheets,” said Nusseibeh in an interview with Reuters. In his mind, large global companies are great investment candidates at today’s prices. As a result, investors could be well-advised to minimize bond exposure and shift into stocks, where appropriate.

Go International by Investing Here at Home
Look more specifically at the geographic spread of your portfolio. International markets, including emerging ones in South America and Asia, are still expected to outperform developed economies like the United States. As such, it makes sense to position portfolios for international growth, which stems from a growing market for middle-class consumers in key countries such as Brazil, China and India.

U.S.-based investors are unique in that many of the large companies headquartered here have already caught on to the compelling growth prospects of certain international markets. In fact, close to half of all of the sales of the S&P 500 stem from overseas. There is certainly a compelling argument to letting well-run, large companies navigate more uneven emerging markets and gain this exposure by investing in the domestic index.

Average into Your Assets
The above recommendations qualify as tactical approaches to shift into assets or areas of the market that could experience stronger near-term performance. A sensible rebalancing program will shift a portfolio toward its defined asset allocation, which is laid out in an investment policy statement. For instance, keeping an asset allocation mixed between half stocks and half bonds should be rebalanced at least annually, if not every six months or quarterly. Minimizing bonds within a reasonable range also makes sense.

The Bottom Line
Portfolio rebalancing is a vital component of any successful investment plan. The above strategies should help you sleep more soundly at night and keep a long-term perspective toward investing.

Read more: http://www.investopedia.com/financial-edge/1212/rebalancing-your-portfolio-for-the-fiscal-cliff.aspx#ixzz2GdnxjFE5

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