Every four years, it seems like the election is the most important yet in our history. It’s only natural to wonder what effect it will have on your investment portfolio. I’ve outlined some practical steps you can take if we see a change in the presidency.
When thinking about what to do with your investments, you have three options:
- Stay invested.
- Get out because you fear the wrong person winning.
- Get out temporarily until the dust settles.
I believe the only option is to stay invested. Despite the uncertainty and partisanship, here are four reasons why you should stay the course.
1. Markets tend to go up during and after election years.
While historical performance isn’t guaranteed to repeat itself, we can look at the past to help inform our decision making.
Previously, you can see average market returns both in an election year and the year after have been positive.
S&P 500 Average Return Year Subsequent to Election – 9.9%
S&P 500 Average Return During an Election Year – 11.3%
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Source: S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
2. The market may be ahead of you.
Let’s say you’re a Republican who’s worried a Democratic administration would be bad for stocks. Waiting to react until we know the election results would be too late—the market would react before you had the chance to “get out.” The temptation would be to get out ahead.
But what if I told you the market may have already accepted this scenario?
The prices of stocks reflect all available information. Right now, a Biden presidency (and even a Democrat-controlled Senate) is a very real possibility. If Biden wins, it wouldn’t catch anyone off guard.
This is why it’s so difficult to trade the market (instead of simply buying and holding). You don’t know what the market has already priced in. If the market is going to crash if Biden wins, don’t you think it would have already started doing so?
3. No patterns emerge between Republican or Democratic presidents.
What about long-term trends? As you can see below, the market has trended upward across both Republican and Democratic administrations.
4. It’s hard to get back in.
Don’t underestimate the difficulty of getting back in the market if you make a change now. Let’s say you get out and you were right, the market sells off. The problem is we don’t know when the market hits bottom. There is no “all-clear” signal. The temptation is to keep waiting on the sidelines.
If you were wrong and the market goes up, it’s equally as hard to reinvest. We don’t like to be wrong, and we keep waiting for a drop to reinforce our belief.
What you should be doing to prepare for a (potential) new president.
There are practical steps you can take to prepare for a possible change in leadership. Biden has already revealed his proposed tax plan, which offers financial planning opportunities if elected. If you’re a Stewardship Financial client, we will work together to take advantage of or adjust your plan depending on new tax laws.
Features of the Biden tax plan include:
1. Retirement Contribution Credit
Biden proposes a flat 26% credit of the amount saved in a tax-deferred retirement account. This would replace the current tax deduction. The result would be a smaller incentive for those in higher tax brackets to save in a pre-tax retirement account.
Likewise, high income earners may find more motivation to save in Roth accounts.
Although we don’t know if this tax bill would come to fruition, a Democrat-controlled White House and Senate would increase the likelihood. If this happens, you may want to explore Roth conversions before year-end to set yourself up for the ability to make Roth contributions going forward.
2. Elimination of the step-up in basis rules for inherited assets
Beneficiaries have enjoyed favorable tax laws when inheriting assets. For someone inheriting an asset with a low-cost basis, the basis “steps-up” to the value on the date of death, thus saving the beneficiary on taxes.
Biden is proposing to eliminate the step-up rule. This means people in all tax brackets would see increased taxes on their inheritances.
For families looking to leave a legacy to their kids and grandkids, it may be wise to consider incorporating a permanent life insurance policy to your estate plan. Life insurance proceeds are tax-free!
The president is only one of thousands of factors that matter to the market.
Does the president affect the stock market? Absolutely. But who is in office is just one of thousands of factors that matter to stock prices.
For instance, Biden’s proposed increase in the corporate tax rate would hurt corporate profits. But that is only one input. What about the accommodative monetary policy that is likely to continue? The stock market is a machine that is constantly taking these various inputs and figuring out what prices should be. Only emphasizing one factor is dangerous to long-term wealth building and preservation.
