Mistakes Investors Make During Election Years
This year has been a whirlwind. The global pandemic and its subsequent shut-down of the global economy wreaked havoc upon financial markets and our normal day-to-day lives. As with any exogenous shock to financial markets, large bouts of volatility ensued. While we progress closer toward a possible vaccine and a return to normality, the pending election brings about another question mark for markets and investors. At the surface, the election seems like a natural event every four years, something markets understand, but rarely provide a smooth ride for investors. While past performance is not indicative of future performance, looking back throughout history markets have continued to track higher regardless of who is elected to office. Madison believes it is important to keep a long-term investment perspective in general, but even more so during election years.
Capital Group, the well-respected manager of over $1.7 trillion including the American Fund mutual funds held in many Madison clients’ portfolios, recently published research showing the three main mistakes investors make during election and primary years. Capital Group’s research provides good reminders that elections results have little influence on long-term returns, to expect market volatility and view it as an opportunity, and to stay invested to reach your long-term goals.
3 Mistakes Investors Make During Election Years (excerpts) by the Capital Group’s Rob Lovelace, CFA and Darrell Spence, CFA, with emphasis by Madison
Investors worry too much about which party wins the election
“There’s nothing wrong with wanting your candidate to win, but investors can run into trouble when they place too much importance on election results. That’s because elections have, historically speaking, made essentially no difference when it comes to long-term investment returns.
“Presidents get far too much credit, and far too much blame, for the health of the U.S. economy and the state of the financial markets,” says Capital Group economist Darrell Spence. “There are many other variables that determine economic growth and market returns and, frankly, presidents have very little influence over them.”
What should matter more to investors is staying invested. Although past results are not predictive of future returns, a $1,000 investment in the S&P 500 made when Franklin D. Roosevelt took office would have been worth over $14 million today. During this time there have been exactly seven Democratic and seven Republican presidents. Getting out of the market to avoid a certain party or candidate in office could have severely detracted from an investor’s long-term returns.
By design, elections have clear winners and losers. But the real winners were investors who avoided the temptation to base their decisions around election results and stayed invested for the long haul.
Investors try to time the markets around politics
If you’re nervous about the markets in 2020, you’re not alone. Presidential candidates often draw attention to the country’s problems, and campaigns regularly amplify negative messages. So maybe it should be no surprise that investors have tended to be more conservative with their portfolios ahead of elections.
Since 1992, investors have poured assets into money market funds — traditionally one of the lowest risk investment vehicles — much more often leading up to elections. By contrast, equity funds have seen the highest net inflows in the year immediately after an election. This suggests that investors may prefer to minimize risk during election years and wait until after uncertainty has subsided to revisit riskier assets like stocks.
But market timing is rarely a winning long-term investment strategy, and it can pose a major problem for portfolio returns. To verify this, we analyzed investment returns over the last 22 election cycles to compare three hypothetical investment approaches: being fully invested in equities, making monthly contributions to equities, or staying in cash until after the election. We then calculated the portfolio returns after each cycle, assuming a four-year holding period.
The hypothetical investor who stayed in cash until after the election had the worst outcome of the three portfolios in 16 of 22 periods (73% of the time). Meanwhile, investors who were fully invested or made monthly contributions during election years came out on top. These investors had higher average portfolio balances over the full period and more often outpaced the investor who stayed on the sidelines longer.
Sticking with a sound long-term investment plan based on individual investment objectives is usually the best course of action. Whether that strategy is to be fully invested throughout the year or to consistently invest through a vehicle such as a 401(k) plan, the bottom line is that investors should avoid market timing around politics. As is often the case with investing, the key is to put aside short-term noise and focus on long-term goals.”