Why You Should Look Forward to the Coming "Fiscal Cliff"

This article published with permission from InvestmentU.com.

A little over a year ago, I gave guitar lessons around the West Palm Beach area.

Turned out, one of my students’ fathers, Mike, was a former hedge fund manager. Mike was in his mid-40s, retired, and living comfortably with his family on a catamaran yacht in Delray Beach.

When he realized I wrote about finance, we often talked about the markets, the economy and investment ideas.

And one day, he said something to me that I’ll never forget.

“I love it when the markets tank,” Mike said.

At first, I thought it was an incredibly pompous thing to say. But after he had a chance to explain himself, in actuality, Mike was saying what every investor should really be thinking.

No, he didn’t mean that he enjoys watching people lose money or seeing the economy go down the tubes.

Mike meant that when investors are scared, they often make irrational decisions with their portfolios. And he knows that’s when it’s his best chance to find shares of companies at deep discounts.

In other words, Mike understands that when the markets are volatile, there will be a number of opportunities to take a risk and potentially make a lot of money.

Let’s just take a look at the past few years.

In 2008, we experienced one of the worst financial fallouts in history. Stocks plummeted the most we’ve seen since the Great Depression.

But this fallout didn’t happen when times were bad or even uncertain. On the contrary, just before the crash, everybody was making money and most people thought the sky was the limit.

By the same token, just when people thought things couldn’t get any worse in 2009, the S&P 500 started to make an impressive comeback. In fact, the S&P 500 has more than doubled in value since then.

What can investors take away today?

The coming months are filled with uncertainty.

For instance, many economists are warning about the risk of the United States hitting its “fiscal cliff.” We saw what happened to stocks last August when Standard & Poor’s downgraded U.S. debt because of the then-looming fiscal cliff.

Then, as my colleague Jason Jenkins wrote about last week, starting in 2013, the health care-reform law is set to add a 3.8% Medicare surtax to unearned income — including dividends, interest, capital gains, rents and royalties — to anyone earning more than $200,000 if they’re single, or $250,000 if married and filing jointly with modified adjusted gross incomes.

And this isn’t all.

The Bush-tax cuts are also set to expire in January, as well. If Congress doesn’t act, the rate on dividends will jump to 39.6% and the rate on long-term capital will spike to 20%.

All in all, $550 billion in tax hikes and spending cuts will take effect Jan. 1, 2013 unless Congress and the president take action to stop it.

Needless to say, many advisors are suggesting investors sell their stocks before the end of the year as a result.

But no one can predict just how badly stocks will fall — if at all. However, if the stock market does take a hit from the “fiscal cliff” you might want to consider it an opportunity to look for some of your favorite stocks at a nice discount.

Mike Kapsch is part of the research team at InvestmentU.com. See more articles by Mike here.