While most experts agree that some 11th-hour agreement will be reached ahead of the August 2 debt-ceiling deadline, uncertainty about the deal and the country's debt situation is starting to take its toll on the markets. On Tuesday morning, 10-year Treasury bond yields held at around 3 percent, but the Dow Jones Industrial Average and S&P 500 indices were down slightly, perhaps pointing to a potentially painful change of fortune that could hit investors hard.
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But even with a potential U.S. default just days away, there are tried-and-true strategies investors can use to help insulate their portfolios from market shocks. "A lot of furor could happen over the next week," says Kate Warne, market strategist at Edward Jones. "In the long term, investors' success or failure is much more likely to be determined by the actions they take in their portfolios, than by any decision being made in Washington."
Above all, experts caution against making hasty moves as the clock ticks down to the debt-ceiling deadline. "The downside risk of some sort of default is dramatic, [but] what specifically should investors be doing to guard against this event? Like any 'black swan' event, there's really nothing you can do," says Erik Davidson, deputy chief investment officer at Wells Fargo Private Bank. "You've got to stay diversified and maintain liquidity."
Here are a few other ways to keep your portfolio on track while the debt-ceiling debate swirls in Washington:
Keep cash on hand. Having adequate capital reserves helps investors manage short-term fluctuations in the market without derailing long-term investment plans. While the amount is different for every investor based on his or her comfort level, experts recommend having at least six months' worth of living expenses on hand. "We call that your 'sleep-well number,'" Davidson says. "Whatever it is when that emergency comes, you don't break the glass, you don't completely upend your entire investment strategy."
But having adequate reserves doesn't mean going overboard and completely cashing out, as some investors did when the market tanked in 2009. "That's a mistake too many people made," Davidson says. "They said, 'I'm out," and they hit the rip cord and they're regretting it now because the market's up 100 percent."
Diversify income streams. Skittish investors continue to flock to U.S. treasuries as the debt drama in Europe unravels, but experts caution against relying solely on T-bills for fixed income. Branching out to corporate bonds and municipal bonds can give investors not only a more diversified income stream, but prevent concentration of risk in their portfolio. Dividend-paying blue chip stocks and real estate investment trusts (REITS) can also shore up investors' revenue streams.
"If you've got a lot of government treasuries because you've always seen that as the safest, I'm not sure I would change that," Warne says. On the other hand, shorter-term government debt yields continue to hover near historical lows, and adding corporate or municipal bonds to the fixed-income mix can give investors diversification and better yields. "You might get a slightly higher yield and you're taking a slightly different risk," she adds. "What you're trying to do is pick different types of risk in the hopes that you're not going to experience them all at once."
Look for opportunities abroad. "Let's not forget that 97 percent of the population, three quarters of the world's economic production, and two thirds of the world's capital market valuation is outside of the United States," Davidson says. "We're probably the most parochial investors on the planet and we need to become much more global in our outlook."
Especially alluring for investors is the burgeoning middle classes in developing parts of the world such as India and China. "Yes, the emerging markets have run quite a bit, but you've got to be excited about two billion people coming into the global middle class." An uptick in consumer demand abroad can translate into big gains both for multinational businesses domiciled in the United States and those headquartered abroad.
Above all, investors must keep their cool as debt-ceiling talks heat up. "There are always headlines and forces of uncertainty in the markets," Warne says. "This one is certainly attracting much more attention than usual, but it's not necessarily going to be different than any other worry investors have. If you've built a well-diversified portfolio, you're prepared for this type of volatility."