With the upcoming election next month, you may be wondering how the outcome will affect your financial life. It’s a very normal thing to ponder – we are constantly inundated by news saying things like “the stock market will crash if this candidate wins” or “buy these 3 stocks if this candidate wins”.
This type of uncertainty can be unnerving, and you may find yourself wanting to make some major changes in your life. However, making any changes based upon an election can be detrimental to your finances.
The purpose of this blog is to outline some of the investment history of elections, discuss how to approach investing new cash now and also talk through how some changes may be coming from a tax planning perspective if Biden wins.
But first, let’s talk about why you are thinking about making a change.
We are hardwired to want to make changes to our investments
The investing world is the only industry that I can think of where the best thing you can typically do is…nothing. But this is really difficult.
We are hardwired to desire changes and tweak things if sh*t hits the fan so we feel like “we did something”. How else do I explain trading away Alvin Kamara from my 5 – 0 fantasy football team? Everything is working perfectly, but I had the desire to do something.
In addition, we are bombarded with news and headlines about how the stock market will crash or major changes are coming to the economy. It is really difficult to ignore the news when your hard-earned money is invested in a diversified portfolio that frankly, you can’t control.
Think back to March when the stock market was tanking. It was very natural to want to sell or do something, but in hindsight, it would have been detrimental to your investment portfolio if you sold in March.
This ties back to the fact that most people are hardwired to be more loss averse. In other words, we feel more pain when something doesn’t work compared to the joy we feel when something does work.
So as you are reading this, I want you to know that it’s okay to want to make a change to your existing investments, but it’s not okay to actually make a change to your existing investments. Here’s why…
Statistics show that presidential elections have very little impact on stock markets in the long run
Here is a chart from Dimension Fund Advisors that shows the hypothetical growth of investing $100 in 1929 all the way to June 2020. The blue parts show a Democratic president and the red parts show a Republican president.
Source: Dimensional Fund Advisors
Past performance is not a guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. In US dollars. Growth of wealth shows the growth of a hypothetical investment of $100 in the securities in the Fama/French US Total Market Research Index. The chart begins with the start of the first full presidential term (March 4, 1929) for which Fama/French Total US Market Research Index data is available and ends on June 30, 2020. Data presented in the growth of wealth chart is hypothetical and assumes reinvestment of income and no transaction costs or taxes. The chart is for illustrative purposes only and is not indicative of any investment. Fama/French Total US Market Research Index: This value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.
As you can see from the chart, the stock market rose in almost every president term (both Democratic and Republican), but with some shorter-term bumps in the road. This aligns with the fact that on average, we experience a recession every 4 years or so.
This next chart shows the annualized return of a 60% stock, 40% fixed income portfolio since 1860 with the purple bars being an election year and the grey bars being a nonelection year.
Source: Vanguard calculations, based on data from Global Financial Data as of December 31, 2019. Data represents the 60% GFD US-100 Index and 40% GFD US Bond Index, as calculated by historical data provider Global Financial Data. The GFD US-100 Index includes the top 25 companies from 1825 to 1850, the top 50 companies from 1850 to 1900, and the top 100 companies by capitalization from 1900 to the present. In January of each year, the largest companies in the United States are ranked by capitalization, and the largest companies are chosen to be part of the index for that year. The next year, a new list is created and it is chain-linked to the previous year’s index. The index is capitalization-weighted, and both price and return indices are calculated. The GFD US Bond Index uses the U.S. government bond closest to a 10-year maturity without exceeding 10 years from 1786 until 1941 and the Federal Reserve’s 10-year constant maturity yield beginning in 1941. Each month, changes in the price of the underlying bond are calculated to determine any capital gain or loss. The index assumes a laddered portfolio that pays interest on a monthly basis. All returns assume dividends/interest coupons are reinvested into their respective indexes. Average returns are geometric mean. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
On average, the investment portfolio actually did better (8.9%) in election years vs. nonelection years (8.1%). Yes, there were some down years, but the overwhelming majority of election years produced positive stock market results which reinforces the fact that markets increase over time.
A key component of creating a customized investment strategy for your family is planning for long-term investments to in fact be… long-term. In other words, temporarily declines in the stock market have zero impact on your life with proper financial planning.
So how does the election impact your long-term investments? It doesn’t.
But how should you invest new money?
I do believe there is a difference between deciding on a plan to invest new money vs. deciding to change your existing investment portfolio.
Let’s say you are sitting on a large chunk of cash (I’d say $100,000 or more). This is where a strategy called dollar cost averaging could come into play. With dollar cost averaging, you invest a set amount of money each month over a pre-specified time period. For example, if you have $120,000 to invest, you may invest $10,000 evenly over 12 months. This may make you feel better given the possible short-term volatility with the election and the fact that we are still in the middle of a global pandemic.
Now, the statistics say that on average, you are better off investing everything at once because stock markets rise over time. However, if we always acted based upon statistics, then you also would feel more safe skydiving (0.0007% chance of dying) vs. driving a car (0.0167% chance of dying).
This is where behavioral finance factors in. Behavioral finance helps explain the psychological influences and biases that impact our behavior. In other words, behavioral finance can help explain the gap between what we are supposed to do and what we actually do. This is one of the biggest values of working with a financial planner – they help you reduce that gap.
How would you feel if you invested your entire life savings today and the next month it dropped 20%? Probably not great. I view dollar cost averaging as more of a behavioral strategy to help make sure you are comfortable with an investment plan so you are can sleep at night and don’t abandon ship when the market is declining.
So how should you invest a large amount of cash you are sitting on? I think it’s a conversation that you should have with your partner and your financial planner, but you may want to invest it over time given some of the short-term uncertainty (election and global pandemic) and the fact that it could make you feel more comfortable. However, you need to feel okay that you are possibly leaving money on the table because over the long-run, markets rise.
The Biden Tax Plan could impact households earning >$400,000 per year
Unlike the long-term investment world, the presidential election could have a major impact on tax planning for high-earning households.
According to Joe Biden’s tax plan, there would be some significant changes to households earning >$400,000. Some key changes include:
- Increase the highest tax bracket from 37% to 39.6% (where it was before 2017) and have the 39.6% rate begin at $400,000. The current highest tax bracket kicks in at $518,400 (if filing single) and $622,050 (if filing joint).
- Eliminate the 20% qualified business income (QBI) deduction. This provides business owners with a 20% tax deduction on any net income generated from their business.
- Cap the value of itemized deductions at 28% (so your effective tax bill would reduce 28%) as opposed to using the marginal tax rate (up to 39.6% in this proposal) to calculate the effective tax savings.
- Increase long-term capital gains rates to ordinary income rates above $1 million of income. This means as opposed to the current 20% maximum capital gain rate, you would pay 39.6% on capital gains (plus 3.8% net investment income tax) on capital gains over $1 million.
Consistent with Joe Biden’s messaging about lowering tax for households earning <$400,000 per year, he is also proposing some enhanced tax credits (which are more valuable to lower to mid income families since they reduce tax 1 for 1). These proposed credits include:
- Increasing the child tax credit from $2,000 per child under 17 to $3,600 per child under the age of 6 and $3,000 per child over the age of 6. You currently receive this credit if your income is under $200,000 (single) or $400,000 (married filing jointly).
- Increasing the child and dependent care credit from $3,000 for one child and $6,000 for 2+ kids to $8,000 for one child and $16,000 for 2+ kids. You receive this credit if you pay for daycare in order for both spouses to work.
- A first-time homebuyer credit for up to $15,000.
If your household income exceeds $400,000, then you should be prepared to possibly make some changes before the end of 2020 such as accelerating business income, realizing capital gains and possibly loading up on itemized deductions.
If your household income is less than $400,000, it doesn’t seem like much would change for you. I guess you could buy a home and have babies to lower your tax 🤷♂️?
- Consider the act of reading this blog as doing something to confirm that your long-term investment strategy should not change. Sometimes you just need that extra confirmation and I hope this blog did that.
- Speak with a financial planner if you are sitting on a large amount of cash. There are a lot of variables that go into investing the right amount of cash and you want to be sure that you will stick to any possible investment plan. This means investing over time via dollar cost averaging could make sense for you.
- If Biden wins, it may make sense for you to communicate with your financial planner and CPA about any possible year-end tax planning strategies you should implement.
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