Deal or No, the U.S. May Be Downgraded: Why Investors Can’t Rest Easy in the Short Term

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Illustration by Alexander Ho for TIME

At a reception this past weekend for former Secretary of State Henry Kissinger, who is promoting his new book, On China, the onetime statesman said he had never seen Democrats and Republicans so at odds. It wasn’t hyperbole. He really did mean never, and Kissinger saw some standoffs in his day.

Partly for that reason, I’m finding it difficult to celebrate the debt-ceiling deal. With animosity across the aisle so pitched, the deal may yet fall apart. Even if it sticks, there remains a huge chunk of fine print to hash out. Some $1.2 trillion of cuts have yet to be determined. That’s more than half the cuts in the package. Only in Washington can such a sum be a trifle to deal with later.

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So the arm wrestling is far from over, and with elections nearing, there is no telling how this will all sort out. One thing is clear, though: The deal won’t necessarily stop ratings agencies from downgrading U.S. debt and removing the country’s invaluable triple-A status. That event would send shock waves through the retirement plans of millions of Americans.

The deal produces only half the cuts needed for U.S. debt to remain “riskless,” ratings agencies say. A downgrade is likely to come in a matter of days, and it might be two notches, not just one, says David Nanigian, assistant professor of investments at the American College. “The cost of credit is going up for everyone,” he says.

There is good news buried in that statement if you are a retiree seeking income. You can expect higher yields from bonds and bank deposits. So consider keeping your income-generating securities on the short end. That way, you’ll be able to hold them to maturity and roll into higher-yielding vehicles without losing any principal. Treasuries are still safe. They just aren’t the no-brainer they once were, says David Littell, co-director of New York Life Center for Retirement Income. To spread risk, he suggests adding some income through an immediate fixed annuity offered by a top-rated insurance firm.

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Also consider boosting your allocation to foreign stocks and bonds through a mutual fund or exchange-traded fund. Higher interest rates in the U.S. will mean a sluggish economy, which will weigh on U.S. assets and possibly drive the dollar lower. Foreign holdings, especially stocks of foreign companies with little exposure to the U.S. economy — generally small-cap foreign stocks — offer some shelter. You might allocate as much as 20% of your portfolio to such investments.

The debt deal gives us some breathing room as a nation. But our fiscal problems are far from solved, and if Kissinger is right about the unprecedented acrimony in Washington, not much is certain about where this outline of a deal leaves us.

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