The U.S. government may be in need of LearnVest’s Get Out of Debt Bootcamp.
Last week, the U.S. hit its debt limit, or the total amount that Congress has authorized the Treasury Department to borrow. This week, Congress is supposed to hold a vote on raising that debt ceiling without requiring spending cuts, but pundits predict that the ceiling will not be raised unless there are some serious budget cuts. If that ceiling isn’t raised at all, the United States government could default on its debt by August, according to Treasury Secretary Tim Geithner.
This has led some regular investors to wonder whether they should have misgivings about buying government bonds. Traditionally, bonds are safer investments than stocks because they come with less risk (read this for background on how stocks and bonds work). When you buy a bond, you’re essentially acting as a lender—whether you’re lending to a government or a company, that institution will pay you back the money you lent plus interest. The higher the risk that the person you’re lending to won’t pay you back, the higher the interest you’d charge. Traditionally, government bonds have been very stable, but investors are currently starting to get skittish. Should you be concerned that you won’t get your money back after all?
What if the rest of the world thinks that America doesn’t have its act together?
Why Defaulting is a No-Go
Our country has faced this question before, and in the past Congress has always raised the debt ceiling in the end—51 times, in fact, since 1978. So, yes, the U.S. could default on its loans, but odds are that Congress will raise the ceiling…and require serious budget cuts to the tune of $1 trillion to do so.
According to the Wall Street Journal, many professional investors are pulling away from government debt because they’re concerned that the U.S. will just keep running up unsustainable deficits. What’s even more worrisome to some investors than the specter of defaulting (which probably won’t happen) is the possibility of “financial repression” (which actually might). What that means is that the government could dig itself out of debt by doing things like tweaking interest rates to make money cheaper and compelling financial institutions to buy its debt, like, as the Wall Street Journal puts it, “geese being force-fed for foie gras.” Actions like these would make bonds a lot less profitable for investors, at least after you take into account the effects of inflation.
So, Should You Ditch Your Bonds?
As a result of this whole ordeal, you might want to ease up on buying long-term government debt, but that doesn’t mean you should give up on all bonds entirely. LearnVest always insists that investing is a long-term process, so keep your eye on the prize…which, in the case of retirement, might be as much as 40 years in the future. So, don’t freak out about the potential to lose some money on the markets; a lot will change between now and then, and time will help mediate the risks you take by investing. On average, the stock market has gone up about 7% per year historically, though some years have been crazy highs and some years have included crashes.
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Even if you avoid government bonds, you can still generally look to corporate and other bonds as a safer investment than stocks (which is why they generally tend to earn you less profit). The most important thing when investing for the long term is to maintain a balanced portfolio with lots of different investments. Maintain a healthy mix of mutual funds that cover stocks, bonds, and other assets that make sense for you, your risk profile, and your investing needs.
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Sometimes the stock market is great, and sometimes it’s not. What do these swings mean for your portfolio? Read this.
Image credit: Kevin Krejci on Flickr