The two questions posed above are not that unordinary when we think of how we deal with uncertainties. At the root of it, we are acknowledging a risk to our (financial) well-being, contemplating which actions we should take to mitigate that risk (the markets may temporarily react unfavorably to the election environment) and narrowing our focus to what can immediately provide comfort (going to cash could protect one’s portfolio from potential market downturns). This appears to be a reasonable thought process, applicable in many facets of our lives.
However, as investors our emotions can be our worst enemy when riding out the ebbs and flows of the market. Focusing on the ebbs and flows of the U.S. stock market since 1926 (as measured by the S&P 500 Index; a widely used benchmark for U.S. large cap equities), the months of October and November tend to underperform during election years versus non-election years. This is where our focus can naturally narrow, to how can we mitigate the pain of potential market losses by “getting out” of the market, while re-investing at a later time.
In our view, the solution involves the distinguishing qualities of an investor contrasted to a speculator.
Oftentimes, the decision to implement no material portfolio allocation changes can benefit the patient investor. While was down in excess of -30% (as measured by the MSCI All Country World Index; a widely used benchmark for global equities) from mid-February to late-March of this year, it has mostly rebounded since then (as of the writing of this article) benefitting investors who maintained their investment fortitude. Those investors who decreased their equity holdings after the early year market challenges may have missed out. This is an outlier example as the market recovery this year since March has been the swiftest on record. Over multiple market cycles since 1980 through September 30th, 2020, the U.S. large cap stock market has on average fell by nearly -15% within each calendar year and despite this, has generated positive calendar year results nearly 75% of the (according to FactSet, Standard & Poor’s and J.P. Morgan Asset Management). Leading up to election time frames, the stock market can react unfavorably in the short run; however, it tends to be resilient over the long term (over multiple market cycles).
Conversely, the speculator believes in the fallacy of timing the market. To our earlier question, why not sell risk assets such as equities and go to cash before a potential market drawdown caused by the election, and later get back in? This is no longer investing from our perspective, this is speculating via a three-part parlay wager: Precisely predicting when to exit the market, when to get back in and which asset classes to re-invest into. There are stories of those who have successfully timed the market; however, we advocate against speculating as it can be predicated on correctly predicting all three moving parts previously listed.
By example, a study conducted by the University of Michigan in 1994 found that 95% of the U.S. large cap stock market’s gains were concentrated in 1% of all trading days over a 31 year period (this was an average of three days per year, albeit an example ending in 1994). More recently, an investor who stayed invested in the S&P 500 Index for the 15 years ending in 2019 earned nearly double than someone who missed out on the market’s 10 best days (missing out on the market’s 30 best days would have resulted in a negative return while the market was up nearly +10% per year over this frame) – according to a study conducted by Putman Investments. This reflects the value of staying invested and not jeopardizing your family’s long-term wealth goals. The market’s best and worst trading days tend to be clustered which creates tricky navigation for the speculator. Not to mention, the investment fallacy that there is a consistent link between political party victories and market outcomes. We are not dismissive about politics mattering; however, the stock market has gained on average +9.2% during Democratic Presidential terms and +9.1% during Republican Presidential terms from 1965 to 2019 (according to Thomson Reuters, Bloomberg and Alliance Bernstein).
We believe in remaining watchful of the candidates’ proposed policies. However, in our view making significant portfolio risk profile changes based upon speculation (speculating on the election outcome and/or speculating on which proposed policies may be implemented), can be a tempting, yet flawed approach that runs counter-intuitive to productive wealth management success. Even the most well-designed investment portfolio can be derailed if our emotions are allowed to be in the driver’s seat. Rather, we advocate with our clients the importance of practicing stoicism and adherence to their financial goals.
