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What the debt ceiling debate means to investors

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POSTED: July 28, 2011 7:30 a.m.

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If you’re like most Americans, the term “debt ceiling” probably didn’t mean that much to you until recently.
Now, of course, the debt ceiling debate is front-page news, day after day. As a citizen, you’re no doubt hoping the situation is resolved in the best interests of the country. But as an investor, you may be especially concerned about what might happen to your holdings, and your overall investment strategy, if the debt ceiling is not increased by the Tuesday deadline.
Before you consider how the situation may affect you, let’s quickly review just what is meant by the term “debt ceiling” and what might happen if no agreement is reached.
Essentially, the debt ceiling is the legal limit on borrowing by the federal government. If Congress doesn’t increase the limit, borrowed funds wouldn’t be available to pay bills, so the U.S. could be forced to default on its debt obligations, which would be unprecedented.
No one can really predict what might happen if the debt ceiling isn’t raised, but virtually everyone agrees that it would be an undesirable outcome. That’s why Congress has, more or less routinely, always raised the debt ceiling in the past. In fact, it’s been raised every year for the past 10 years.
This year, however, political and philosophical differences between congressional leaders and the current administration have, thus far, blocked the lifting of the debt ceiling.
Nonetheless, there’s still time for Congress to take action before Tuesday, which is the estimated date of when temporary actions to avoid default are exhausted. (The actual debt ceiling was reached in mid-May). And as an individual investor, here’s what you can do:
• Don’t panic. It’s hard to imagine that an agreement won’t be reached to raise the debt ceiling, even if such a deal doesn’t happen until the last minute. But even if the Tuesday deadline passes, the U.S. may still find ways to make payments on its debt for a while. So don’t rush into investment decisions based on this scenario.
• Overlook short-term results. Even if the U.S. finds ways to pay its debts after the Tuesday deadline, lenders – who don’t like uncertainty – could become more concerned and start demanding higher interest rates on their investments in U.S. Treasury securities.
As a result, market interest rates could rise across the board, leading to declines in bond and stock prices. Remember that the market can drop for any reason, and this would be no exception. While such a drop could well be sharp the resulting distress would likely jolt Congress into taking quick action on the debt ceiling.
    Don’t let debts and deficits drive your investment decisions. Even after the debt ceiling issue is resolved, concerns will exist about the country’s debt and deficit issues. As an investor, you should make investment decisions based on your individual goals, risk tolerance and time horizon rather than the level of debt being incurred by the government.
The debt ceiling story can certainly be unsettling – but it doesn’t mean you should let the roof fall in on your investment strategy.

This article was written by Edward Jones for use by Laura Evans, Edward Jones financial advisor of Richmond Hill.

 

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