Debt-limit brink: Can ordinary investors run for cover? Should they?

As the clock ticks down on the debt-limit deadline, financial advisers say the worst thing ordinary investors can do is panic and sell. The assumption is still that some kind of deal will get done.

By Mark Trumbull, Staff writer / July 28, 2011

Specialists Douglas Johnson (l.) and Scott Wetzel work at their post on the floor of the New York Stock Exchange on July 28.

Richard Drew/AP

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Don't panic and sell all your investments, but don't have your head in the sand either.

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In a nutshell, that's the advice that many financial professionals are giving as the clock ticks down toward either a deficit-cutting accord or a federal gridlock scenario that could mar America's credit rating and shake financial markets.

One reason for that advice is a widespread expectation that, when push comes to shove, politicians will agree on a deal rather than risk the wrath of voters by allowing inaction to foment a financial crisis.

Another reason is that it's not easy to risk-proof a portfolio against something as profound as a breach of confidence in the US dollar and the world's largest economy.

Normally, Treasury bonds are called the haven of safety when other financial instruments are going haywire. But if Democrats and Republicans can't "get to yes" on a plan to raise the current cap on federal borrowing (with a linked plan to reduce future federal deficits), then those very Treasury bonds would immediately come under at least a degree of selling pressure.

Failure to reach a debt deal could also send stock prices down sharply as well, as the Treasury's inability to pay all its bills would translate into less economic activity. Some finance experts say that even money-market mutual funds might be at risk of a rare decline in share value, if confidence in short-term debt markets (including Treasury debts) were shaken.

But the dire scenario is not viewed as the likely one.

"We believe the best course of action is probably to tune out the ever-changing headlines and political rhetoric, and maintain a long-term focus," the investment company Vanguard says in a recent statement to clients on its website. " 'Wait and see' may not be the most satisfying answer to this question [of what to do], but we think it's the right one."

Other financial companies have offered similar advice, warning that investors can often damage their nest eggs when they react to short-term events. In many cases, markets rise as doom scenarios prove unfounded. In others, a dive is followed by a quick rebound, making it notoriously hard for investors to time their moves perfectly.

So is the right course to do nothing?

Maybe a better way to put it is to simply assess your overall financial plan, including a gut-check for how sensitive you are to short-term volatility. Some moves that might make sense for the long-term might also position you for a bit more safety in a US-default scenario.

"It would be better to be in bank deposits rather than money funds," says Greg McBride, a senior financial analyst at Bankrate.com in North Palm Beach, Fla. It's not that money-market mutual funds are likely to drop in value during the weeks ahead, but holding your cash fund in a bank money-market account gives you the added protection of coverage by the Federal Deposit Insurance Corp. (FDIC).