Investing during an election year can be tough on the nerves and 2020 promises to be no different. Politics can bring out strong emotions and biases, and it is natural to draw a connection between the government in power and the influence they may have on markets.
However, many renowned economists and in-depth studies caution investors against making short-term changes to a long-term plan to try to profit (or avoid losses) from changes in the political landscape.
Benjamin Graham, the father of value investing, famously noted that "in the short run, the market is a voting machine, but in the long run, it is a weighing machine". Maybe he wasn't literally referring to the intersection of elections and market volatility, but markets can be more volatile during election years, with sentiment often changing as quickly as candidates open their mouths, as we are witnessing in New Zealand politics.
Graham first made his analogy in 1939, in his seminar book Security Analysis. Since then there have been 22 presidential election cycles in the US and 26 general elections in New Zealand. We have analysed them to help you prepare for investing in these potentially volatile periods.
Predicting which party wins the election:
There's nothing wrong with supporting a candidate or a party to win, but investors can run into trouble when they place too much importance on election results. That is because evidence suggests elections have, historically, made 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 US economy and the state of the financial markets," says 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 NZ$1 investment in the S&P 500 made when George H. W. Bush took office in 1989 would be worth NZ$21.89 today. During this time there have been two Democratic and three Republican presidents.
Likewise, a NZ$1 investment in the NZX 50 made in 1989, when Labour's Geoffrey Palmer became New Zealand Prime Minister, would be worth NZ$17.02 today. During this time there have been four Labour and four National prime ministers.
Getting out of the market to avoid a particular political outcome could have severely reduced an investor's long-term returns.
Trying to time the market:
A study discovered that since 1992, investors have poured assets much more often into cash or low-risk funds leading up to elections. By contrast, equity funds have seen the highest net inflows in the year immediately after an election. This suggests investors may prefer to minimise risk during election years and wait until after uncertainty has subsided.
But market timing is rarely a winning long-term investment strategy, and it can pose a major problem for portfolio returns.
To verify this, a US-based adviser group analysed investment returns over the last 22 US 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. They 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. 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.
Bottom line: Staying on the sidelines has rarely paid off. It's time, not timing. If you are nervous about the markets in 2020, you are not alone.
Elections often draw attention to the country's problems, and campaigns regularly amplify negative messages. But with some guidance from a disciplined adviser, successful investors always stay the course and rely on time in the market rather than timing in the market.
Remember, people have lost more money waiting for the right time to invest than those who have stayed with the market in all phases.
•Graphs of S&P500 and NZX50 performances during USA and NZ election years are included in the online version of the article on our website blog.
Nick Stewart is an Authorised Financial Advisers and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
