How Will My Retirement Funds Be Impacted by the Debt Ceiling?

One of the largest current market concerns is the debt ceiling.  The United States hit the debt ceiling in January of 2023 and there are concerns that the United States could default on their debt as early as June 1st.  With all that in mind, how should you manage your investments moving into this time of uncertainty?  In addition to the management of your investments, I will also cover what the debt ceiling is and the current crisis we are facing as Americans.    

Key Takeaways:

·       What is the United States Debt Ceiling?

·       What Happens if the U.S Breaches the Limit?

·       How Will My Retirement Funds be Affected?

·       Risks of Attempting to Time the Market

·       What Other Impacts Will be Seen?

What is the United States Debt Ceiling?

The debt ceiling is the maximum amount of debt that can be incurred by the U.S. Treasury to cover the Nation’s obligations set by law.  These borrowed funds are typically used to meet existing obligations such as Social Security, Medicare, Interest on National Debt, etc.  The limit has been increased under every presidential administration since 1933, and it has never been reduced.  Since 1960, the debt ceiling has been raised at least 78 times, so you may wonder why this time has been so widely publicized. 

What Happens if the U.S Breaches the Limit?

The United States has only defaulted on its debt one time in 1979.  Although, you still hear people say today that they should purchase Treasury Bills/Bonds/Notes because the US has never defaulted on its debt (false).  One of the main contributors in recent years was the multiple government-sponsored Covid-19 relief programs.   

The current debt ceiling sits at $31.4 trillion which was hit in January of 2023.  The current issue is that the United States cannot increase its outstanding debt further, so how will they meet their obligations? Well, that is the current situation which great minds across the country are trying to figure out.  When the ceiling is reached, there is a vote between suspending or raising the limit.  The House passed a bill on Wednesday (4/26/2023) to raise the debt ceiling and cut government spending.  Which makes sense as no one wants the United States to default on their debt, but what isn’t seen by many is that the vote was extremely tight (217 vs 215). 

In the April legislation, included was a clause that froze government spending at the 2022 level.  This law is set to remain in effect for 10 years so it will be interesting to see the effect of the continued high levels of inflation.  The May negotiations have now begun, and the House speaker has given the White House two weeks to create a spending plan that the Republicans agree with before raising the debt ceiling.  So far, the articles available claim that these conversations are not going well, and little progress has been made.  One piece of information that has emerged from the meeting is that the current predicted time of default (if nothing is done) would be between early June and early August.

How Will My Retirement Funds be Affected?

If the United States defaults on their debt in the coming months, then it will lead to drastic repercussions in the economy.  Companies that were supposed to have “x” amount of money, now had less because the government had to delay their payments.  This would result in the companies having less money, which could result in layoffs and less investment geared towards growth.  Less investment in growth could also lead to a decrease in real Gross Domestic Product. 

This could also result in a decrease in investor confidence.  If individuals and financial institutions fear that the stock market could fall from current levels, then they would reduce their investment in stocks.  Some may even decide to sell their stocks, which could put further downward pressure on the stock market. 

If the crisis lasts long enough to affect Price to Earnings ratios (P/E) then there could be a longer term effect.  You will typically see higher P/E ratios during economic expansions as companies invest in growth, and vice versa during contractions.  Therefore, a contraction in the economy could lead to a decrease in stock prices.  Which would affect anyone that holds any equity positions, including ETF’s and Mutual Fund’s hold them in their portfolios. 

Another consequence could be a credit downgrade on United States sovereign debt.  This happened before in 2011, when Standard & Poor’s changed their rating to AA+.  This happened during the 2011 debt ceiling standoff, which is eerily like what we are seeing in 2023.  Therefore, the stock market could see short and long-term effects from the current crises.

If you want to understand the potential impacts on a more technical level, then check out this report titled Going Down the Debt Limit Rabbit Hole by Moody’s Analytics.

Risks of Attempting to Time the Market

Anyone that wants to try to time the market should consider the following things.  First, just because something happened in the past, doesn’t mean it has to play out the same way again.  For instance, if the debt ceiling issues are fixed quickly and efficiently then it could cause an upward spike in the market.  We really have no idea what is going to happen.  If everyone could efficiently time the market, then they would because you can make a lot of money. Unfortunately there isn’t any way to successfully time the stock market.  To contrast, you could lose a lot of money as well, so you need to understand that before taking the risk.   

JP Morgan published a report that measured the performance of an investment in the S&P 500 index between January 3, 2000, and December 31, 2019.  It was found that if investors bought and held their position (never sold) the annualized return was 6.06%.  However, if you missed the best 10 days of returns during that 20 year period, in which there were 5100 trading days, then your return falls to 2.44% annualized.  If you missed the 20 best days, then your return was .08%.  That’s very powerful to know. We don’t ever know when the good days in the stock market will come and often they come when you least expect them.  Many times right after the bad days.   Market timing will most likely be detrimental to your investment portfolio and long-term success.

Another thing to consider are the tax implications.  If you are trading in an individual, joint, or trust account, then any Short and Long Term Capital Gains will be subject to taxation.  However, if you have Short or Long Term Capital Losses in the portfolio, then could consider selling that investment and purchasing another to create a capital loss.  Those losses can be used as a tax deduction or to offset other gains.  If you are investing in a tax-deferred account such as a 401(k), 403(b), 457, or IRA then no taxes will be incurred.  These accounts do not activate a tax event when positions are sold, no matter how much money has been made.  Taxes are instead paid when the money is withdrawn from the account in the future.

For strategies to help you manage risk during a bear market, check out my podcast, 5 Tips for Dealing with a Bear Market.

What Other Impacts Will Be Seen?

Many individuals would be negatively impacted by a default.  There are many different people that rely on these payments from the government.  This was briefly touched on before, but for one, Social Security payments would be disrupted.  About two-thirds of retirees use their Social Security as their main source of income, so delayed payments would put these individuals in a tight situation.  Many of these retirees are likely not in a position to start working again so they will have to live on a strict budget until the ceiling issue is resolved.

Delayed Social Security payments and unemployment would both lead to less spending in the economy.  Unfortunately, if individuals are no longer spending as much money, then companies make less money.  It may feel like a vicious circle because less revenue would cause further unemployment, but it could also cause certain companies to close or go bankrupt.  This typically affects small businesses first, so if you own a business then you should be aware of these potential effects.

Another area that would be impacted is the wages for Federal employees and Military.  Presumably, these paychecks are their main source of income which would again contribute to less spending.  It could also result in these individuals failing to meet their obligations such as mortgages, car loans, credit card bills, student loans, etc.  Therefore, if you believe that your wages could be impacted, then it could be wise to start an emergency fund.  Typically, we at Morrissey Wealth Management recommend 3-6 months’ worth of expenses which should cover the timeframe until the crisis is resolved.  However, because of all these negative effects congress is unlikely to shut down the government for a prolonged time frame if at all.

If you are worried about the potential impacts of the debt ceiling, then feel free to contact me.  As a financial planner, I could help you determine the best way to invest your funds to best mitigate the effects of the debt crisis.  I offer a free consultation where we can investigate whether my expertise matches your needs.  If you are interested, you can follow the link to my calendar to book a consultation.