Four Fiscal Cliff Investing Strategies

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With fiscal cliff talks stalled in Washington, investors are in limbo wondering how the outcome – deal or no deal – will affect their money.

That's why we've put together the following fiscal cliff investing strategies, thanks to Money Morning Global Investing Strategist Martin Hutchinson, so you can be prepared for whatever happens.

While Hutchinson thinks a deal is likely, it might not come until the early New Year. In the meantime, here's his fiscal cliff investing strategy overview, straight from a recent report for his Permanent Wealth Investor subscribers.

  • Fiscal Cliff Investing Strategy No. 1: Put Dividend Stocks in IRAs and 401(K)s

Since capital gains will continue to be taxed at a favorable rate, growth stocks are at less risk from possible tax rises. Hence your true dividend stocks should go in tax-free accounts.

  • Fiscal Cliff Investing Strategy No. 2: Maximize Your "Roth Conversions" in 2012

There are two types of individual retirement accounts: regular IRAs (in which contributions are tax deductible but withdrawals are taxed), and Roth IRAs (in which contributions are not tax-deductible, income and capital gains are tax free, and withdrawals are not taxed).

Since taxes are going up in 2013 and are likely to trend higher thereafter, you want most of your money in Roth IRAs unless you are very sure your income after retirement will be low enough to be in a low tax bracket. You can't make Roth IRA contributions directly unless your income is less than $100,000, roughly.

However, even if you're rich, you can convert your regular IRAs to Roth IRAs, paying tax on the conversion amount. (Yes, this is silly, it means you can really make a Roth contribution by making a regular contribution and converting it; it was a piece of 2010 legislation that is unlikely to survive Dec. 31.)

Since a Roth conversion pushes up your reported income and regular IRA contributions reduce it, by doing a Roth conversion in 2012 and making regular IRA contributions thereafter, if your income is just above the $250,000 "rich threshold" you can potentially "de-rich" yourself in 2013 and thereafter. Now isn't that a nice idea!

  • Fiscal Cliff Investing Strategy No. 3: Not All "Dividends" Count as Dividends

Some companies' annual payouts mostly count as return of capital or capital gains. Funds paying dividends out of capital won't attract the dividend tax.

And some are paid out of cash flow rather than income, and are not taxed as dividends.
In all these cases, we need to be sure that the company is generating enough cash flow to increase its value, and not just liquidating itself.

  • Fiscal Cliff Investing Strategy No. 4: Get Your Hedges in Place

If we do go over the fiscal cliff, markets will definitely react.

The main economic effect will be to reduce the long-term federal deficit by about three quarters, but cause a short-term recession by taking purchasing power away from consumers. (The recession will be short-term because the cash comes back again in the form of a lower federal deficit, requiring less Treasury funding from the bond markets and freeing resources for private sector lending and investment.)

So I would expect a stock market dip, but a rise in the dollar and a sharp rise in bond markets, taking the 10-year Treasury bond yield below 1%.

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