The presidential election is over, but another day of reckoning
approaches. A "fiscal cliff" consisting of major tax increases and
spending cuts is quickly approaching. And with it, a broad swath
ofinvestments ranging from stocks andbonds to commodities and
currencies, may be affected in the months ahead.
If lawmakers don't reach an agreement by the end of the year,
$532 billion in tax increases will kick in 2013 along with spending
cuts totaling $136 billion in military and other domestic
programs. The problem is that many economists are saying these
huge spending cuts would send the U.S.economy into arecession next
year. In addition, the elimination of Bush-era tax cuts would send
tax rates of federal income,dividends and capital gains soaring.
This means wealthy Americans could seedividend tax rates jump from
a current 15% to as high as 39.5% by next year.
While I hope the fiscal cliff can be avoided, investors
shouldn't just wait passively on the sidelines for events to
unfold. Here are five specific actions you should take to help
protect your portfolio against the negative consequences of the
fiscal cliff...
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1.
Adjust your portfolio to take advantage of
lowercapital gains tax rates
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The tax on capital gains could rise to 20% in the event of a
fiscal cliff, so take the opportunity now to shed riskier
stocks and replace them with high-qualityblue chips that are
better positioned to ride out a downturn. Household names
such as
Clorox (
CLX
)
,
Proctor & Gamble (
PG
)
and
Kimberly Clark (
KMB
)
have dominantmarket shares , sizable cash flows and track
records of at least 25 years of consecutive dividend growth.
You can also look into what we here at StreetAuthoritycall
Retirement Savings Stocks
-- the ones that have a track record of safety and long-term
gains.
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2.
Trim exposure to defense and retail sectors |
More than half of fiscal cliff spending cuts will be to
military programs, so defense stocks will be among the
biggest losers. With a smaller budget,
Lockheed Martin (
LM
)
would likely sell fewer F-35 fighter jets and Littoral Combat
Ships to the military, for instance.
BAE Systems (LSE: BA.L)
would likely see demand drop for its nuclear submarines and
Bradley-armored fighting vehicles as well.
Highertaxes will leave consumers with lessdiscretionary
income , which is bad news for high-end department stores and
restaurant stocks. Luxury retailers such as
Saks Inc. (
SKS
), Nordstrom Inc. (JWN)
and
Tiffany & Co. (TIF)
would probably feel the negative effects of lower consumer
spending as would restaurant chains such as
Yum Brands (YUM)
and
Darden Restaurants (DRI)
.
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3.
Consider purchasing some municipal bonds |
Rising tax rates on dividends increases the appeal of
tax-advantaged investments such as municipal bonds. The
interest that municipal bonds pay is free from federal taxes
and if you live in the state that issues thebond then
interest is free from state and local taxes as well. However,
you should do yourdue diligence before diving into
themunicipal bond pool since some states (California and
Illinois, for example) and many municipalities have big
budget shortfalls that exponentially increasecredit risk .
A bond, like any loan, is only as good as the
borrower'sability to pay , so focus on credit quality. You
can also reduce your risk by holding a diversified portfolio.
For this reason, I recommend purchasing abond fund managed by
Nuveen, Fidelity or other well-known managers, and leaving
the selection of individual bonds to the pros.
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4. Also consider purchasing REITs
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Anotherasset class that becomes more enticing as dividend tax
rates rise isreal estate investment trusts (REITs), which
enjoy a unique tax-advantaged status compared to other firms.
REITs are allowed to deduct the dividends they pay from
theirtaxable income . Instead of being taxed twice -- at the
corporate and shareholder level like most corporate dividends
-- REIT dividends are taxed just once. REIT dividends are
taxed as ordinary income and never qualify for the 15%
dividend rate. This means dividend tax increases won't hurt
these investments.
Among the various property types, health care REITs are
the best defensive investment because of their non-cyclical
nature. Health care spending doesn't change during a
recession. In addition, health care REITs are benefiting from
industryconsolidation and low borrowing costs. A pick to
consider is
Health Care REIT (HCN)
, which is the nation's third-largest health care REIT and
yields about 5%. Its pending purchase of
Sunrise Senior Living (SRZ)
will greatly expand this REIT's portfolio of assisted living
communities. Another safe pick is
Health care Trust of America (HTA)
. This REIT focuses almost exclusively on medical office
space, which is considered the least risky type of health
care property and boasts a nearly 6%dividend yield .
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5.
Look for growth in Latin America |
If the United States falls off the fiscal cliff, then
gross-domestic-product (GDP ) growth will contract next year.
This means investors will need to look beyond the U.S.
borders for growth. Europe's economy is in even worse shape
and China has started to show signs of a slowdown. But Latin
America is still hot. Most Latin American countries are
projected to deliver 4% GDP growth in 2013, with Columbia and
Chile probably registering 5% growth each.
Investing outside the United States is a bit riskier, so I
prefer to invest in large-cap stocks with American depository
receipts (ADRs) listed on a major U.S. exchanges.
Petrobras (PBR)
is the world's fifth-largest oil company and a safe choice.
In the past five years, this Brazilian energy giant has
delivered 26% annualearnings growth and a nearly 4%yield .
Telecom Argentina SA (TEO)
provides fixed-line and wireless telecommunication services
in Argentina. This company generated 33% earnings growth last
year and pays a rich 9% dividend yield.
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Risks to Consider:
Fiscal cliff or not, there are plenty of catalysts to spark
investor fears and a return to extreme market volatility next
year.
Action to Take -->
Investors already have enough to worry about as a result of the
European debt crisis, the United States' meager GDP growth and
weakening corporate profits. Even if some grand deal happens and a
fiscal cliff is avoided, these strategies are all great moves to
reduce portfolio risk and help investors sleep better at night.