What to do to protect myself in the event of a US default.
July 23, 2011 7:48 AM   Subscribe

I'm not saying that I think the US will default in 10 days, but I am nervous enough to start thinking about covering my butt. I have some money socked away. Its not much, but its something, and I would really love for it all not to somehow evaporate.

So half of my savings are sitting in a bank account in USD, collecting dust. I'm not too worried about that, because even if the dollar tanks, I am not going to be using this money outside of the US.

The other half, however, is split up among bond ETFs, specifically these: HYG, LQD, and BND. This is what worries me. I have only a fuzzy understanding of these ETFs and the underlying bonds. In theory, if the US defaults, non-Government bonds should see a boost. On the other hand, some of the companies that have issued these bonds may go bust for whatever reason. Either way, I have no idea how these ETFs would react to a potential default, and whether or not holding onto them would be a good idea.

My understanding of finance and economics comes almost entirely from listening to Planet Money, so financefilter, please set me straight. Also, to be clear, I am not looking for investment advice and I'm not trying to make money. Rather, I'm looking for any perspective on how the aforementioned ETFs should react to a default.
posted by tempythethird to Work & Money (10 answers total) 8 users marked this as a favorite
Remember that bond prices move inversely to interest rates: if interest rates spike bond prices go down. A number of hedge funds of which I am aware are sitting on piles of cash in anticipation of scooping up Treasuries at bargain prices (because interest rates may spike).
posted by dfriedman at 7:56 AM on July 23, 2011 [1 favorite]

To hedge against a US default (short of literally hedging vs USD - Not a bad idea, using short term currency futures to give you a month or three past 08/02 to see how things will shake out), bonds make a poor choice.

Personally, I like regional ETFs not highly dependent on either US consumers or US debt. So China, bad idea. Emerging markets that sell mostly to China, good idea. OPEC countries, good idea (regional instability aside, everyone needs their oil). Eurozone, bad idea. South America, maybe (they performed amazingly over the past decade but have stagnated for the past couple years).

And never forget the trend that has held through all of human history - In bad times, the vices do very very well.
posted by pla at 8:11 AM on July 23, 2011

"I have only a fuzzy understanding of these ETFs and the underlying bonds."

Then you shouldn't be in them, period. Default or not.

Rule number 1 of investing is to thoroughly understand the securities you invest in. Get a copy of the prospectus for each ETF and study them carefully.
posted by mikeand1 at 8:12 AM on July 23, 2011 [3 favorites]

I really hope I'm not wrong on this but I don't think there will be a default. Even the Republican leaders are saying that the debt ceiling needs to go up, it's just a matter of what will be in the bill. As far as I'm concerned, there is no "if the debt ceiling doesn't go up."
posted by kat518 at 8:57 AM on July 23, 2011

The thing is, a US default would be unprecedented and the effects would be completely unpredictable. The whole global financial system is built on the bedrock of US treasuries being risk-free, and the system is continuing to assume that default will not happen (interest rates are not rising) because they have no other way to price things if that is not true. When that changes literally overnight, no one knows what would happen to corporate bonds or even the structure of ETFs. On the one hand, corporate bonds become more valuable relative to government bonds because there is now demonstrated risk in US bonds. But if the US government shuts down, is the economy really going to function for very long? And on the other hand, a default in a couple weeks would not be caused by debt problems like Greece for example. Eventually Congress would get it together, increase the debt ceiling and borrow or monetize the debt to cover payments. So who knows?
posted by Durin's Bane at 9:09 AM on July 23, 2011 [1 favorite]

I just heard a (first term) Republican Congressman on NPR who does not think there is a problem. In his view there is plenty of money to cover the government's obligations, and the checks will go out on August 3. No need to panic.
posted by Cranberry at 9:15 AM on July 23, 2011 [1 favorite]

It is difficult to make recommendations without knowing your total financial situation but I can make general comments on your three ETFs.

HYG is a high yield bond fund, otherwise known as junk bonds. It is at highest risk if there is some shock to the financial markets.

Second is LQD. These are high rated corporate bonds with an effective duration of 7.1 years. They will lose value if interest rates spike. They are exposed to default risk if companies go bankrupt.

The safest of the three is BND, which holds a broad range of high rated corporate and U.S. Treasury bonds. It has an effective duration of 5.1 years which means that is will be affected somewhat less than LQD by an interest rate rise and has less risk of default because it has a lower percentage of corporate bonds.
posted by JackFlash at 10:39 AM on July 23, 2011

I just heard a (first term) Republican Congressman on NPR who does not think there is a problem. In his view there is plenty of money to cover the government's obligations

These guys are the crazypants ones saying the government can just pay the interest on the debt. It's probably true that there is no reason to panic but the uninformed opinion of the freshman class of Republic tea partiers is not evidence for that.

tempethethird: mikeand1 has given you the correct advice. If you don't understand what you're investing in, you shouldn't be investing in it. You should just be in some sort of index fund if you want to invest in something. Some people might say not even that, but I understand the desire to have your money somewhere besides under your mattress.
posted by Justinian at 12:29 PM on July 23, 2011 [2 favorites]

mikeand1 and Justinian
You're both totally right, and I'm dumping the blame for this on my younger dumber self. Said younger self did not realize the necessity of understanding an investment vehicle before investing in it. In defense of younger self, a giant bundle of bonds seemed like a decent conservative alternative to sticking money under my mattress (which is what a savings account is these days.) Its not like I bet my life savings on a cold-fusion startup.

Now seems to be as good a time as any to educate myself, as opposed to getting out as rashly as I got in, and I have set about trying to read (and understand) the prospectus. Its not entirely human-readable though, at least not for the educated layperson.

I just heard a (first term) Republican Congressman on NPR who does not think there is a problem.

I don't know about you, but to me this is the exact opposite of reassuring.
posted by tempythethird at 12:44 PM on July 23, 2011 [3 favorites]

I'm not totally sure how to set this up from the US (I've kind of drifted into it, through inheritance) but most of my money is now in an Australian bank, in Australian dollars. The Australian economy is doing fairly well at the moment, mostly because of China's voracious appetite for primary resources. The Australian Reserve Bank is keeping short-term interest rates fairly high, so you can get a good interest rate from the bank at the moment. If you give the bank the tax file number 888 888 888, the interest will be subject to Pay As You Go witholding, and you don't have to do anything else tax-related on the Australian end. I haven't yet needed to figure out exactly what you do on the US end to report the interest and pay tax on it, but at least you only need to deal with it in one country.

Anyway, I'm planning to keep the money there for the time being, because at the moment I think the Australian government is far less likely to do anything which will drastically degrade their currency than the US government.
posted by Coventry at 7:05 PM on July 23, 2011

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