Fiscal Cliff (Ways to Prepare for the Fiscal Cliff)

In the first few days after the election, influential voices in both parties (notably House Speaker John Boehner and the president himself) have struck a conciliatory tone. But we still don’t know whether that pact will hold — or whether an agreement can be reached in the few days before Congress takes its holiday recess.

If that doesn’t happen, investor confidence could erode rapidly, triggering a bear market for stocks in 2013. The difference between coming to an agreement and not doing so could be as much as a 20% rise or fall in the stock market next year (stable earnings multiplied by a higher price-to-earnings ratio).

Given the drastic contrast between the possible outcomes, set a high priority on capital preservation. However, you also don’t want to miss out on stock bargains — and the opportunity to earn double-digit returns in the next 12 months.

Use the following checklist to guide your strategy:

1) Beef up your holdings of bonds and cash.

Reliable income plays like the Vanguard Intermediate-Term Investment Grade Fund (MUTF:VFICX) capitalize on some of the best bonds to buy right now. VFICX features an average maturity of 6.3 years for the bonds in the fund’s portfolio. Thus, if interest rates were to climb in the years ahead (as seems inevitable at some point), it wouldn’t take too long for the fund to replace maturing bonds with higher-yielding new issues. Conservative investors appreciate that sort of protection.

In addition, don’t be afraid to park some money temporarily in FDIC-insured bank money market accounts. Your principal is safe, and the most competitive banks are now paying 1% or slightly more, with no minimum deposit. My honor roll includes Barclays Bank Delaware and Sallie Mae Bank. Remember, cash gives you the freedom to invest in discounted assets at a moment’s notice.

2) Prune stocks or mutual funds that could cause trouble in the months ahead.

To raise cash for new investments, you might need to unload some old ones. It doesn’t matter whether you’re holding an old investment at a gain or a loss. Instead, ask yourself whether that stock or mutual fund is likely to keep pace with the market over the next 12 to 18 months.

If Wall Street analysts are projecting lower earnings for a company in 2013 than 2012, that’s a yellow flag. Likewise, if a mutual fund has lagged its peer group for the past three years, consider cutting bait.

Richly valued “glitz” stocks like Baidu (NASDAQ:BIDU), LinkedIn (NYSE:LNKD) and Zillow (NASDAQ:Z) are especially vulnerable in this environment. The latter two in particular are trading at ludicrously high valuations, so get rid of them on the next S&P rally of 3% or more.

3) Buy discount-priced stocks of businesses that provide essential goods and services.

In recent weeks, panic over the prospect of higher dividend taxes has pummeled the share prices of many solid, well-run utilities like Allete (NYSE:ALE) and Duke Energy (NYSE:DUK), making them attractive buys.

In addition, I advise you to bulk up on familiar names like Coca-Cola (NYSE:KO), IBM (NYSE:IBM) and McDonald’s (NYSE:MCD) — all of which have been nicked lately by fears of a global growth slowdown.

While some kind of slowdown probably will, in fact, materialize, these outfits sport a long track record of innovative product development and marketing — and a corporate culture that thrives on challenge. They’ll be back for another round of the fight!