The next time you pass someone asking for a charity donation, check it’s not someone from the American government. America is currently having money troubles, and there’s a good chance it could impact your investments.
I’m going to explain everything you need to know about America’s debt woes, the effect similar events have had in the past and what you can do to prepare your portfolio.
[top_pitch]
Why is America running out of money?
The US has something called a debt ceiling. Sadly, it doesn’t mean that the roof of the White House is stuffed with dollar bills.
A debt ceiling is just a pre-agreed limit to government borrowing. The reason America is getting uncomfortable is that it’s fast approaching that ceiling.
If Congress doesn’t agree to increase the debt ceiling, America won’t be able to pay back some of its loans. As a result, the country would default, something that it’s never done before.
When will America run out of money?
According to Treasury Secretary Janet Yellen, the US has until 18 October before its coffers run dry.
The debt ceiling was first established in 1939 and has been lifted on more than 100 occasions. So it’s not unusual for America to spend and borrow more money than planned.
Right now, America is nursing debt of around $28 trillion (£21 trillion)!
[middle_pitch]
Why would America running out of money be bad?
The US defaulting on its debt would be similar to you missing a mortgage or credit card payment. And just as you missing a payment would affect your credit score, if America fails to stay below its debt ceiling, it would affect the country’s credit rating.
A lower credit rating makes it more expensive for the US to borrow money because it would be deemed a riskier customer. This would have a massive knock-on effect on the rest of America’s finances. The aftershock would trickle down to businesses, residents and the stock market.
What happened to investments in the past?
Back in 2011, America faced a similar situation. It was resolved at the last moment, but not before the US credit rating was dropped from AAA to AA+, even though the US didn’t actually default.
This simple change led to the S&P 500 index dropping by close to 7% in a single day. It wasn’t quite a stock market crash, but it was certainly a significant dip.
Stock markets around the world also suffered, but that was partly due to similar debt issues in Europe and elsewhere.
The issue in 2011 came about partly because of the 2008 financial crisis. And the troubles the US is now facing are largely due to the aftermath of the coronavirus pandemic and huge government stimulus spending.
How could this impact your investments?
America’s looming debt trouble coupled with the Evergrande crisis in China has already created pain in the markets and you may have noticed a drop in your portfolio’s value.
There’s still uncertainty around both situations, so I wouldn’t be surprised if there is more global stock market suffering before the end of the month. As a result, you may see some of your investments depreciate further.
What can you do to prepare your investments and portfolio?
Although markets may fall further in the short term, that doesn’t mean it’s time to sell everything and run for the hills.
The best course of action is probably to do nothing.
Prices are looking gloomy simply because of the current uncertainty. However, it’s more likely than not that these issues will be resolved. And once they are, markets will recover, and you don’t want to miss out on that bounce.
It is important to make sure you’ve got a healthy level of diversification in your portfolio. Having too much concentration in one country, asset, or industry could leave you at risk.
Final word
Do you even remember the crisis of 2011? I doubt it. If you’re a long-term investor, you’ll know that these kinds of events pass swiftly and become nothing more than a blip on your timeline.
So selling out of positions might be unwise, but buying shares during the dip could mean you pick up some bargains.
Even though history tends to repeat itself, it’s important to remember that past performance doesn’t dictate future results. There are no guarantees when it comes to investing, and you may get out less than you put in.
