Just when you thought you could take a break from financial drama, following the resolution of the debt ceiling issue, here comes Act 2: the downgrade of the U.S. long-term credit rating. As a citizen, you may be feeling frustrated. And as an investor, you might be getting worried. But is this concern really justified?
Certainly, it was news when Standard and Poors (S & P) lowered the U.S. long-term credit rating from AAA to AA+. This was, after all, the first time that the U.S. has lost its AAA status since its initial publication 70 years ago. Furthermore, S & P put a negative outlook on the rating, which means that further downgrades are possible. But despite these developments, there's no reason to think that the sky is falling in on the investment world. Consider the following:
•"Downgrade" doesn't mean default. Rating agencies such as S & P assign ratings to bonds to help investors measure credit risk — the chance that they won't receive timely payments. The downgrade to AA+ just means that investors would be slightly less likely to receive future payments than if the bond had an AAA rating. This is far different from a default, which would result in investors not receiving current payments.
•U.S. credit rating is still high quality. S & P didn't change the U.S. government's short-term credit rating, which applies to debt maturing in less than one year. Furthermore, even the long-term rating of AA+ is still considered high quality. Also, keep in mind that two other major rating agencies, Moody's and Fitch, both affirmed their AAA rating on the U.S., although Moody's has a negative outlook on its rating.
•Downgrade was not a surprise. Because the downgrade had been rumored for weeks, the financial markets may have already "priced in" some of the impact. While it's possible that interest rates may rise, it's also important to note that similar downgrades of other countries' debt in the past have not resulted in significant rate jumps. As for the stock market — which was already volatile, partially due to the debt ceiling issue — the negative reaction we've seen to the downgrade will likely be short-term.
This downgrade should not be as calamitous as we've been led to believe. Corporate profits, always a key driver of stock prices, are still strong, and with the market correction we've seen in the past couple of weeks, many quality stocks now appear to be more attractively priced — which means it may actually be a good time to look for investment opportunities that make sense for you, rather than heading to the "sidelines."
In any case, you never want to overreact to any one piece of news. If you were to make big changes to your investment strategy, you'd likely incur fees and expenses — and, even more importantly, your portfolio might no longer be positioned to meet your long-term goals. You're much better off by sticking with a strategy that's based on your individual needs, risk tolerance and time horizon. This can be challenging, especially in light of the screaming headlines. But remember, although past performance isn't indicative of future results, the U.S. financial markets have seen plenty of traumas in the past, and have survived — and usually, eventually prospered.