How to Manage Your Finances in the Face of Uncertainty

What is the debt ceiling and how does it impact you today? The United States hit the current $31.4 trillion limit on January 19th, 2023, and has been operating under extraordinary measures since then. Treasury Secretary, Janet Yellen, has indicated that extra measures will be exhausted as early as June 1st, triggering potential default.

As I’ve accumulated years in my career, I’ve had the fortunate or unfortunate opportunity to observe the machinations of Washington and its stance on the debt ceiling. Here are lessons learned on the debt ceiling and how you should manage.

In spite of alarming headlines, the debt ceiling fits into a variety of short-term painful events that can be managed with investment discipline and attention to the details of your financial plan. We’ll review the circumstances we face as well as strategies you can use to manage your finances through the uncertainty.

What is the Debt Ceiling?

The debt ceiling refers to the maximum amount of money that the U.S. government is authorized to borrow to meet its obligations. These obligations include Social Security payments, tax refunds, interest on the national debt, and defense expenditures. Historically, adjusting the debt limit was a routine legislative process. However, in recent decades, it has become politicized, leading to increased market volatility during debates and negotiations.

It’s worth noting that placing a debt limit on the federal government is relatively rare globally. Only the US and Denmark have formal debt ceilings. Most countries focus on managing deficits as a percentage of GDP rather than having a specific dollar amount as a ceiling. Deficits do remain a concern for every country, and their impact on economic growth and stability must be carefully monitored.

A Century of Political Wrangling

The concept of the debt ceiling originated in 1917 as a means to gain support for the United States’ entry into World War I. Since then, the debt ceiling has been modified numerous times to accommodate the country’s growing obligations, including social safety net programs, military expenditures, and pandemic relief measures. Over the years, both Republican and Democratic administrations have contributed to the rising debt, resulting in the raising or temporary suspension of the debt ceiling on multiple occasions.

Since 1960, the debt ceiling has been raised 78 times. Republican presidents have been responsible for 49 of those increases, while Democrat presidents account for 29. No single party has opposed the debt ceiling in the past. In fact, the debt ceiling has been a bipartisan action taken by both parties to ensure the government can fulfill its obligations.

The Messy Reality

While the United States has never defaulted on its obligations, the process of raising the debt ceiling has become increasingly contentious. In 2011, the prolonged debate over the debt ceiling and the growing national debt led to a downgrade of the national debt rating by Standard & Poor’s. This had real economic consequences that were unfortunately self-inflicted. You may not remember, but this time period was also accompanied by a global debt crisis, especially in Europe.

The Significance of the Debt Ceiling

Some economists argue that deficits should be less concerning, especially if the economy is growing faster than the real interest rates. They believe that economic growth naturally reduces the debt-to-GDP ratio over time. However, others emphasize the potential risks associated with a large and growing national debt. These risks include increased interest payments, higher interest rates, lower credit ratings, and the crowding out of more productive investments.

The Consequences of Default

Allowing the United States to default on its obligations would have severe and unprecedented consequences. These consequences may include a decline in the value of the dollar, substantial market volatility, and negative credit rating revisions. Recognizing the gravity of such outcomes, it is highly likely that Congress will find a way to raise or suspend the debt ceiling in 2023.

A Game of Chicken

Unfortunately, modern government and politics leaves plenty of room for blame for each political party. Each party in power in the executive branch has favored a debt ceiling raise when it has come up. Each party in opposition has made that difficult. The stakes continue to get higher as brinksmanship works to outdo itself and in 2023, we have an especially polarized and divided legislative branch, even within the chambers.

The Current Situation and Outlook

As we approach the June 1 ‘x’ date, which represents the estimated point when the Treasury cannot meet its financial obligations, negotiations over the debt ceiling continue. While an agreement remains elusive, there are positive signals indicating progress. A compromise, involving measures such as rescinding unused COVID relief funds and spending caps, is anticipated. It is crucial to remain optimistic that a deal will be reached to avoid the worst-case scenario of default.

Action Items to Navigate the Debt Ceiling

The playbook for managing through a debt ceiling standoff may sound familiar. Basic investment and financial planning truisms can get you through.

  1. Stay Informed: Keep yourself updated on the latest news and developments regarding the debt ceiling crisis. Follow reliable source and don’t give in to temptation of fear mongers or those selling doom and distraction.
  2. Review Your Financial Situation: Assess your current financial situation, including income, expenses, savings, and investments. Understand your cash flow and identify areas where you can make adjustments to ensure financial stability during uncertain times. This is not different than general financial planning considerations. Just make sure your current financial plan is updated to reflect your current life.
  3. Build an Emergency Fund: Strengthen your financial safety net by building an emergency fund. Aim to save three to six months’ or more worth of living expenses in a readily accessible account. Having this buffer can provide peace of mind and help you navigate any unexpected financial challenges. If your emergency funds are in place as is the case for many of our clients, remind yourself that you have cash for short-term emergencies. This can be an important assurance.
  4. Evaluate Your Investments: Review your investment portfolio and assess its alignment with your financial goals and risk tolerance. If you have an investment process and strategy that is monitored and adjusted over time, you should not need a completely new strategy. If you’ve been neglecting your portfolio and risk has grown, evaluate your options for adjustment.
  5. Maintain your mental health: Fear-based media and sales tactics can leave you feeling scared and uncertain. Remember that you have a financial plan (or are going to get one) and make sure that you are focusing on what you can control. The world’s headlines can feel scary. You don’t have to hang onto every word of the negotiations or news of the day to stay apprised. If you feel excessive anxiety, talk to someone who can help to evaluate your situation from an objective perspective. It’s crucial to stay calm and avoid panic during times of financial uncertainty. Emotional decisions can often lead to poor financial choices. Instead, focus on the actions within your control and seek expert advice when needed.
  6. Maintain a Long-Term Focus: While the debt ceiling crisis may cause short-term volatility, it’s essential to maintain a long-term perspective with your financial decisions. Do not scrap your investment strategy unless it is built to shift from day-to-day. At Pearl Planning, we build strategies built to be utilized over and across time. Avoid making impulsive investment moves based on short-term market fluctuations. Stick to your well-designed personal financial plan and investment strategy.
  7. Consult with Your Financial Advisor: This is the perfect time to talk to your financial planner. Revisit your plan, adjust when necessary, and remember that a plan is built for a variety of circumstances. Not sure who to talk to? We’re here to help. Schedule a meeting with a member of our team here.

Summary

This may not be the last time you’ll have to pull out your debt ceiling tool kit. While the debt ceiling debate may lead to increased market volatility, it is important to remember that the United States has never defaulted on its obligations. By staying informed not only about the news, but about your plan, and working with a knowledgeable financial planner, you can navigate these uncertainties and make informed decisions that align with your long-term financial goals.