Indeed, in today’s post-election world, if your stock portfolio has one weakness, one vulnerability, one negative financial field force that is sapping it of its normal strength, it is the long list of dangers related to the nation’s well-publicized fiscal woes.
They carry the threat of recession and the potential for higher tax rates on stock profits and dividends. And that is putting investors’ finances in a weakened state — just as Kryptonite does to Superman.
The fiscal cliff is the one-two punch of tax hikes and deep, mandated spending cuts set to kick in automatically on Jan. 1 unless a divided Congress can agree on a deal to avoid, or at least minimize, the damage that the roughly $600 billion fiscal drag would inflict on the economy.
Fear that Democrats and Republicans won’t get a deal done by year-end — when the investor-friendly Bush-era tax cuts will otherwise expire — has already resulted in a sizable hit to investors’ stock portfolios. In the eight trading days since Election Day, a vote which resulted in a status quo political power structure and more divided government, the Standard & Poor’s 500 stock index has fallen 4.8%.
A report of some progress and an improved tone of cooperation gave stocks a lift Friday, avoiding another down day. But some investors fear a market meltdown similar to the one that occurred in the summer of 2011, when a divided Congress brawled publicly over raising the nation’s debt ceiling. The partisan bickering dragged on so long that it resulted in a credit-rating downgrade for the USA’s triple-A rating, the first in history, a blow that dented investor confidence and resulted in a one-day plunge of nearly 635 points, or 5.6%, for the Dow Jones industrial average on Aug. 8, 2011.
“The market will be choppy until investors get clarity on the fiscal cliff issues,” says Mark Luschini, chief investment strategist at Janney Montgomery Scott.
The direction of the market is one thing, but among other problems, arguably the biggest headache facing investors is how to protect their portfolios from a potential hike in tax rates on capital gains and dividends.
If lawmakers let the Bush-era tax cuts expire at year-end, investors will see the tax rate on capital gains, or profits from stock appreciation, rise to 20% from 15%. And for individuals with income of $200,000 ($250,000 for households), an additional 3.8% investment income tax will be tacked on starting Jan. 1 to help defer the costs of President Obama’s health care law. That means high-income folks will see their capital gains rate rise to 23.8%.