It’s almost 3pm on Sunday, July 31, 2011 as I write this.  We are less than two days away from our nation running out of money and defaulting on our debt.  And, for those of you who may not know…yes, I am in the United States of America!!  The U.S. Government has put itself in the position of not being able to pay its bills.  There’s word today that our illustrious leaders have delayed, until later today, yet another vote on a deal that would, or could, resolve this crisis.  So, it’s possible we may have an agreement by the time I finish writing this.

But, the inability of our leaders (from both parties) to keep us from getting this close to the edge, is not the point of this article. Instead, I will address what I think we, as investors, should be doing to prepare ourselves in the event that an agreement doesn’t happen. 

If you are a client of Rall Capital Management, or of a firm with a similar investment philosophy, then the short answer to the question of what to do is…nothing.  I have received a few phone calls and emails from clients who are understandably nervous.  The financial media and political pundits have been warning of a meltdown in the financial markets if we don’t have an agreement by Tuesday.  And…they might be right.  But, they might not be.  Last week, the markets were reflecting the uncertainty and moved lower, although it wasn’t a dramatic selloff.

Our investment philosophy, and our historical success, is based on not trying to “guess” how the markets will perform.  That’s because we believe that when someone makes a market prediction, that’s all it is…a guess.  Investing can be a very emotional experience, dominated by two emotions, fear and greed.  When you combine a guess about what will happen in the markets with a strong emotion like fear or greed, the results are often disastrous. 

The best way to prepare for the “end of the world as we know it” scenario is to have your portfolio properly positioned before it becomes an issue.  That means to make sure that you have enough liquidity to live your life.  Make sure you have enough cash on hand to pay expenses for several months, so that if the market does take a dive due to the crisis (or for any other reason), you won’t be forced to sell off your holdings at depressed prices. 

This is how we got through the financial meltdown of 2008.  We made sure that clients weren’t living off of the invested assets, then held our breath and hung on when things looked the darkest.  We got hurt, but we didn’t get killed.  And we have recovered nicely over the last couple of years by staying with our strategy. 

The next best thing you can do is to make sure your portfolio is well diversified.  It’s probably true that if the U.S. defaults, the rest of the world markets will also suffer.  So diversification may limit the damage, but probably can’t prevent it.  But different asset classes behave in different ways, so owning a mixture of U.S. and international stocks, real estate and commodities should help. 

I believe that the real key is in your fixed-income, or bond, allocation.  Interest rates have been at record lows for a long time.  Because of the low rate environment, many investors have taken on additional risk in the fixed income side of their portfolio.  They are trying to increase the interest payments they receive, so they either buy longer term bonds, which are by definition riskier; or, they take on additional credit risk, buying lower-rated securities, or higher-risk bonds than they normally would. 

For many, the fixed-income side of their portfolio is supposed to act as the anchor, providing some stability to the rest of their investments.  Adding additional levels of risk to the “stable” side of your portfolio can work well when markets are stable, but can whipsaw you and cause greater losses when markets get shaky.

I just checked the news again…and we don’t have a deal yet in Washington.  So, as we all try to keep the faith that our leaders will come through with a solution, from the perspective of our investments, the best advice I can offer is to “prepare, not panic.”