5 Ways to Protect Yourself From the Looming Fiscal Cliff
Erin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There is a “fiscal cliff” looming in front of us. Recently, the non-partisan Congressional Budget Office warned that without action by Congress to avoid a fiscal cliff, (or Taxmageddon) Americans should expect the loss of 2 million jobs, and a probable recession. A “fiscal cliff,” in simple terms, is the combination of federal spending cuts occurring at the same time as new tax increases. In (Keynesian) theory, the smaller the federal budget (spending cuts), the smaller the economy (less money being put into the economy by the government, while taxing people more). And unless Congress intervenes, current law creates just that- significant cuts in federal spending, and for tax increases.
How did this happen? Didn't anyone see it coming before this? Yes. The federal spending cuts are a result of the budget deal Congress and President Obama reached in order to avoid a federal government meltdown/shutdown, and allowed the government to pay its bills. It was a temporary measure that relied heavily on Congress being able to create a more effective and permanent solution in the future. The future is now, and there is no solution in sight.
This comes at a time when the housing market was just about to turn the bend. July pending home sales were at their highest level in over two years. Home prices were up 1.2% since September 2012. And Fannie Mae announced that residential investments (home buying) in 2012 would positively contribute to the GDP for the first time since 2005. (Source: Forbes) But a fiscal cliff would be the end of that. Two million jobs lost would mean lowered demand for new homes, and a return to more foreclosure filings.
So how do individual investors, everyday Americans, protect themselves from a fiscal cliff?
First, call your Congressional representative and make your voice known. Know the issues and which options Congress has available, and support one.
Second, understand capital gains taxes. Investments come with pros and cons. We invest, we wait, we earn, and we hope to cash out more than we put in. We call it “making my money work for me.”
But Americans also get to make money to give to Uncle Sam. It is our right, or privilege, as citizens to contribute to the finances of the government that grants us freedom and protection. The more money we make, the more money the government makes, thanks to capital gains taxes.
In the case of unemployment, recession, or a “fiscal cliff,” investors may be tempted to withdraw their money. Whether it be for living expenses, retirement, or out of fear that a stock will plummet, withdrawing investments may not be the smartest decision.
Capital gains taxes work against the very system that benefit from them. For instance, if you invest and sell stock within the first year that the company goes public (not necessarily the same year you invested in the company), it is considered a “short-term capital gain.” Please pay Uncle Sam 35%.
However, if you hold on to that same stock for one more year, the rate is reduced to 15%. It would seem wise to wait for one more year before cashing out, in order to not have to pay 20% more in capital gains taxes. But no matter when or why you cash out, you will have to pay taxes.
Now here's the thing that doesn't add up from the government point of view. The sooner you have your cash back in your pocket, it is that much sooner that you can reinvest it, or put it back into the economy. If you were to choose to invest again, you could put it into more companies, and directly help spur business growth. That growth alone benefits not only the company and your long-term investments, but the economy in general as more jobs are created, commerce encouraged, and taxes are paid.
The sooner you have your money back, everyone wins. So where is the argument in favor of capital gains taxes? Why would Uncle Sam want to make you wait longer or penalize you by taking more from you? Well, easy. Right now Uncle Sam needs your money desperately. See above: fiscal cliff.
Third, invest well now. Find the companies with the best dividends that will benefit you in the future without having to cash out and risk capital gains. Look to companies with strong consumer brands, such as Unilever (NYSE: UL), Procter and Gamble (NYSE: PG), and Colgate-Palmolive (NYSE: CL) to hold their value. Even in a recession people have to eat. They may not eat out anymore in an effort to save money, (so avoid investing in restaurant chains) but they will still buy ice cream for dessert at home. All three companies have also proven a fair amount of reliability in previous economic climates.
Colgate brings in more than half of its sales from emerging markets, protecting it from economic difficulties or market problems in any one specific country. The company has growth potential in Brazil, India, and several Asian countries. A recession in the U.S. will impact other countries as well, but this strategy should insulate Colgate from fall-out in the States.
The same goes for Unilever. The company boasts a widely diverse product lines from body lotion to ice cream. The company is just as widely diverse across the globe as it is among product lines. The company features several loyal and popular name brands, including Ben and Jerry's and Klondike, and Dove and Axe. With global popularity and brand diversity, Unilever will stay strong even when the economy does not. The dividend is reliable and sustainable.
Procter and Gamble is nearly double the size of Unilever. However in the most recent quarter, P&G's revenue declined by 1% year over year, which is to be noted. But, in spite of the 1% decline, P&G brought in an impressive 44.7% rise in earnings over the year previous. The company pays a high dividend, and like its competitors, also features international diversity and strong household brand names.
Avoid companies that rely on the advertising dollars of other companies in order to make money. When a business model relies upon the financial viability of others', and not upon the company's actual product, the company tends to not weather economic storms well. (See: Dot com bust.) Stick with the companies that produce necessities!
Fourth, stay abreast of the news and follow the trends. Energy looks to be an important sector and key player in the fight to avoid the fiscal cliff. For instance, a carbon emissions fee (puts money into government's pockets, with minor impact on taxpayers), developments in Congress and off-shore drilling, the Keystone Pipeline, etc.
Fifth, get your personal ducks in a row and make sure your paycheck comes from a financially solid company. A chance of the government being able to bail out corporations during the spending cuts does not look good.
ErinAnnie has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend The Procter & Gamble Company and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.