Responding to election results: Smart planning or unrewarded market timing

Economic, legislative and world events — like the recent U.S. elections — are bound to have an impact on the emotional response of looking at stock market opportunities. Keeping an even keel is a discipline.

In order to help guide decision-making and stay focused on a long-term approach to investing, investors often have an Investment Policy Statement in place.

Ideally, implementing this investment policy means using tools and approaches that maximize expected returns while abiding by risk tolerances and restrictions laid out ahead of time. (Restrictions can incorporate items such as the desire to use ESG or sustainable investment options to implement your plan.)

So, what types of things prompt you to change your investment policy?

Ideally, adjustments are the result of changes in risk tolerance, changes in needs and goals, and new or fewer restrictions on your portfolio.

But what about political events? What if taxes change? What if you are worried about taxes? What if you think things are going to go well or go poorly? How do you incorporate that?

Let’s delve into those types of questions.

Costs always matter

In constructing a portfolio, it’s important to realize that costs, fees and taxes always matter and always impact your long-term wealth accumulation.

However, it’s a very different thing to stay invested and manage taxes and fees from your portfolio versus choosing to become uninvested and dramatically change your portfolio characteristics over possible tax implications. It’s important to stay invested over time. And in doing so, selecting investment vehicles that offer attractive fees and smart tax management can improve your overall return.

You can see the impact of tax management on returns over time. It’s significant. Like all cost management, it impacts the overall expected return, but it also means that managing tax costs within your portfolio becomes more important as taxes rise. In fact, all investment options should be reviewed for costs and fees as well as tax management to give you an approach offering the best after-tax return. Using these tools helps you best navigate the changing waters of tax policy.

Impact of tax management on returns

Impact of tax management on returns

Source: Aperio1

Also note that political changes do not always equal economic policy shifts. And economic policy shifts may not impact portfolios exactly as you expect. So before you shift your entire investment approach, let’s review the possibilities of tax changes in the coming years.

Anticipating tax levels and changes in the tax code

There are several factors driving speculation about possible changes in the tax codes. First, there has been an unprecedented amount of spending on economic stimulus as a result of the COVID-19 pandemic. The second factor is the shift of party control to a Democratic President with narrow Democrat margins in the Senate and House of Representatives.

There is not broad support for any specific tax approach, and that means this process will take a bit of compromise to implement. But it is anticipated that tax impacts will affect households making $400,000 or more and, in some cases, those earning $1 million or more. It is not clear if deductions may be limited at higher income levels or capital gains and dividends may be taxed at higher rates. For others, there may be an expansion of tax credits that benefits their situation.2

Economic stimulus

There is likely to be additional stimulus to keep the economy growing. This spending targets individual benefits (e.g., unemployment and stimulus checks, etc.), business benefits (e.g., PPP loans and other measures of relief) and health coverage (e.g., vaccine research and distribution, and medical equipment supply). These continuing costs are a tradeoff in supporting the economy but make tax increases more likely.

Democratic control of legislature

With these factors, tax increases are on the table. But we should note that the narrow margins of representation and inconsistent policy support among the Democrats mean that policy will only become law through compromise. Note that the Senate is really at a split of 50/50 between Republicans and Democrats, with Vice President-elect Harris — once she is in office — able to cast a vote, creating 51/50. This is literally the narrowest of margins. And the House of Representatives also holds a narrow margin. So this is not a carte-blanche structure to pass legislation.

Coupled with the narrow margins, there is not consistent policy ideology within the Democratic party. And this means that there is not an agenda that will be immediately approved.

One thing investors should know about tax changes is that if they do occur in 2021, they are most likely to take effect in 2022. Investors should therefore have time to understand the changes in detail and their personal impact, as well as to plan for those changes prior to them taking effect. This is part of the investment and planning process and should continue to be incorporated as you move forward.

The composition of the legislature branch does have other impacts. Cabinet members are likely easily approved. Note that President-elect Biden’s proposed appointments thus far have been centrist. However, structural legislative reform, such as ending the filibuster in the Senate or changing the Electoral College, will be more difficult to pass with narrow margins and a diverse party.

There has been some concern expressed about executive orders, but executive orders have limits in their use. Please note that the tax code cannot be altered by executive order, only by an act of Congress.

Market reaction

So far, markets have continued their upward trend at the beginning of this year, despite the finalization of election results. It’s very reasonable to expect high levels of volatility to persist, but there does not seem to be an immediate fearful reaction playing out in market pricing. This is a very short period of time to measure market performance and volatility, but it serves to show that even as the market prices reflect known information, there is not a sharp and immediate adjustment.

Market timing

One word of caution is about market timing and making adjustments to your portfolio based on how you believe certain events and factors will play out in market performance. We all like to identify items that we think will be born out specifically in the market, but market timing rarely works and most typically causes portfolio losses or underperformance. Market timing trades have proven to be especially difficult to apply to geopolitical events and to make an investment that may reap the benefit of your prediction.3

Political fallout has proven the most difficult to predict and therefore to implement a strategy to take advantage of such a prediction. They are really exogenous shocks to the system. But typically, the true value of the underlying companies remains in place.

Markets have rewarded discipline

Growth of a dollar — MSCI World Index (net dividends), 1970–2019

Growth of a dollar — MSCI World IndexIn U.S. dollars. MSCI data © MSCI 2020, all rights reserved. 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 no guarantee of future results.

Note in the above chart, there were many geopolitical events, commodity pricing events and others. This chart ends in 2019, but we can think about the experience of the last year and coronavirus fears in this category as well. And yet, for disciplined investors that stayed invested during these events, they ended up maximizing their long-term expected return.

This is a great time to make sure that you have an updated financial plan and have planned for short-term expenses. But in the long-run, maintaining a market discipline that involves staying invested — while choosing investment vehicles that offer tax-managed returns at reasonable fees — offers you the approach that has a history of providing great opportunity to enhance investment returns. If you’d like to discuss creating or updating your financial plan, contact an advisor at Wipfli Financial.

CONTACT AN ADVISOR

Responding to election results

Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC); however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services, fees and conflicts of interest is set forth in Wipfli Financial’s current Form ADV Part 2A brochure and Form CRS, copies of which are available from Wipfli Financial upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Janice Deringer

Consultant

Janice L. Deringer is a member of Wipfli Financial's Investment Committee and a consultant who focuses on serving individual and corporate clients. She brings over 20 years of institutional investment management experience to her strong interest in educating women and individuals regarding financial decisions, realities and possibilities.

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Responding to election results: Smart planning or unrewarded market timing

time to read: 6 min