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Listener and reader Frankie Glass from Burbank, California, asks:
Everyone is talking about the possibility of the U.S. defaulting on its debt and the effects that would have on the economy and world markets. What about the effects on individual investors — those of us with 401(k) accounts and other investments? How can we protect ourselves from what could be catastrophic fallout?
Negotiations between the White House and Republican leaders to avoid a default on the nation’s $31.4 trillion debt have stalled.
Earlier this week, President Joe Biden and House Speaker Kevin McCarthy had been in promising talks about a deal to raise the debt ceiling, the amount of money the U.S. government can borrow to fulfill its existing obligations.
But on Friday, McCarthy said, “We’ve got to get movement by the White House, and we don’t have any movement yet.” The reversal occurred just a day after McCarthy said he could “see the path” toward an agreement.
The two sides have been in a standoff as Republicans called for steep spending cuts and work requirements for low-income people who receive federal aid, among other demands. But progressive lawmakers have expressed concerns about the concessions Biden could end up making to the GOP.
Treasury Secretary Janet Yellen has warned that failing to raise the debt ceiling could cause the U.S. to default on its debt as soon as June 1, which could lead to “economic catastrophe,” she said.
The fallout would be unpredictable, but many experts say that should the government default, the delivery of Social Security and Medicare benefits and other forms of federal assistance could be delayed. It could also spur higher borrowing rates for mortgages and other loans. The financial markets could panic, which would impact all participants. That includes people with savings in retirement plans like 401(k)s, which are typically invested in a mix of stocks and bonds.
We’ve already seen how the debt limit talks have buffeted the stock market. During the week, stocks rose amid improving prospects for a deal, but declined after talks were held up.
Third Way, a center-left think tank, said that the typical worker nearing retirement could lose $20,000 in savings.
“With approximately 60 million US workers invested in 401(k) plans, these losses would hurt households in every American community,” the organization wrote.
Third Way projected how much workers could lose if there were a 22% drop in the S&P 500 Index. It derived the 22% figure by gauging the midpoint between the S&P’s decline during the 2011 debt crisis (17%) and the findings of a 2021 report from Moody’s Analytics that estimated how much the index could tumble as a result of a short-term debt default (27%).
Kelly LaVigne, vice president of consumer insights at Allianz Life, said if you’re regularly contributing to your 401(k) or any retirement plan your employer offers — which you should be — then you’re investing for the long term anyway.
So try not to panic, he said.
“The best advice is to turn off the noise as much as you possibly can to keep on with your plan,” LaVigne said.
LaVigne advises against trying to “time the market” by selling your investments, then buying at what you might think is the right time.
“That’s something I would discourage at any time, but especially right now, when everything is so volatile,” LaVigne said. “You want to just stay the course, get some professional advice and plan for the next time that something like this happens, because it’s going to.”
Greg McBride, chief financial analyst at Bankrate, said he would advise consumers to try to boost their emergency savings and pay down their credit card debt, since we’re already in a high-interest-rate environment and we may face a recession within the next year. And that’s without even taking the nation’s debt troubles into account.
McBride said the ideal cushion for most people would be enough money on hand to cover six months of expenses. For those who are their family’s only breadwinner or self-employed, he recommends building enough savings to cover nine or even 12 months’ worth of expenses.
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