Presidential Elections and Your Portfolio

MONEY TALKS – The 2016 presidential race may be the most tumultuous election the country has ever seen. Americans have been voicing their opinions now more than ever and the polls are expecting to see a record numbers of voters next Tuesday. Unfortunately, much like the national debates, the lead topics of conversation at the dinner table have not revolved around political policies. Rather than discuss the economy, foreign policy, immigration, or the Supreme Court, many Americans have been following the candidates’ leads and talking about email scandals and sexual misconduct. The result of these lewd conversations has left a negative taste in the mouths of democrats, republicans, and independents from Maine to Hawaii.

Much of the negative energy from the presidential candidates themselves, political advertisements on television, and conversations with friends and family has transformed into fear and mistrust. In fact, a recent poll by the Washington Post and ABC News showed that 59% of registered voters have an unfavorable impression of Hillary Clinton, while 60% had and unfavorable impression of Donald Trump. It’s clear that regardless of whether Trump or Clinton win the election, the nation is in fear of what the future holds. With more cynicism now than ever, investors are anxiously waiting to see how the stock market reacts to the announcement of the nation’s 45th president.

Unfortunately, the uncertainty surrounding this year’s election has prompted many investors to make dangerous predictions about which presidential candidate will be better for the stock market. Rather than rely on patience and portfolio allocation, many investors are trying to outguess the market based on who they think will win the election. For example, some investors are selling off their investments now, and rather than reinvesting in the market, they are waiting for the election results to determine when or if they’re going to get back in. While enticing, this hasty strategy could lead to costly mistakes and is unlikely to provide any significant advantage. The following illustrative information was compiled by Dimensional Fund Advisors. Exhibit 1 shows the growth of one dollar invested in the S&P 500 over the last 15 presidencies which span just over 90 years.

Exhibit 1: Growth of a Dollar Invested in the S&P 500 January 1926 – June 2016

growth-of-a-dollar-v-2

Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. The S&P data is provided by Standard & Poor’s Index Services Group.

The data clearly shows that there is one key trend; over long periods of time, the market has consistently grown regardless of whether a democrat or republican was in office. Contrary to popular belief, there is no clear pattern that one party or the other will result in better market performance. As a matter of fact, from an investor’s standpoint, staying out of the market is a much more dangerous proposition than either Hillary Clinton or Donald Trump winning the election. By removing oneself from the market, an investor is eliminating any real chance of long-term appreciation within their portfolio.

At Lakeside, we counsel our clients to stick to a long-term investment plan and avoid the temptation of trying to time or outguess the market. Academic research has shown that it is very unlikely that investors can gain an edge by predicting how the stock market will perform based on the outcome of a presidential election. To capitalize in the equity markets, investors should develop a long-term investment policy and stick to the strategy regardless of the latest political headlines.

It’s All about Your Asset Allocation

MONEY TALKS

Asset allocation is the concept of diversifying a portfolio across several asset classes to reduce the portfolio’s exposure to risk. Your asset allocation is critical to the success of your portfolio because it is the driving factor that determines both risk and return. While the specific investment selections you make are important, they are far less crucial than the amount of money you commit to each asset class.

Creating a proper portfolio is a two-step process. The first step is selecting an asset allocation that is aligned with your needs. The second step is selecting the specific investments that fit into the asset classes you selected. Identifying your personal and financial needs is an essential step towards selecting your asset allocation. Traditionally a young investor can be more aggressive than an investor in their sixties because they have time on their side to overcome a market downturn. However, that is not always the case. Your health, job security, cash flow needs, and risk tolerance are all important factors that should be considered when selecting an appropriate asset allocation. The point is, your portfolio should be unique to you and your situation. Just because you and your neighbor are the same age doesn’t mean that you should have the same allocation. Likewise, your allocation at 25 will likely be inappropriate for you at 55. Find an asset allocation that works for you and your current situation and update it as your circumstances change.

Selecting specific investments that fit into an asset class can be a challenge because of the level of detail involved. Asset classes are broad categories of dissimilar investments such as stocks, bonds, real estate, and money market funds. Each asset class can then be divided into specific categories. For example stocks can be divided into U.S. stocks and foreign stocks, while bonds can be divided into taxable or tax-exempt. These specific categories can then be divided again into different styles. U.S. stocks can be divided into small, medium, and large cap. Bonds can be divided into investment-grade or below-investment-grade. This division can go on and on until you have narrowed down a broad asset class into a specific category, style, and sector such as U.S. small cap health care stocks. With thousands of investments to choose from one might ask; how can I possibly select investments that represent all these asset classes, categories, styles, and sectors?

Thankfully there are investments out there that allow an individual investor to create a broadly diversified portfolio at a reasonable costs. Index mutual funds and exchange traded funds (ETFs) are an excellent tool to build a portfolio that has an appropriate allocation where the specific investments fit into the appropriate asset class, category and style. The nature of these funds allow an investor exposure across broad market segments without the time, energy, and cost of purchasing individual securities. In fact, most investors can create a fully diversified portfolio by purchasing 5 or 10 of the right index funds or ETFs.

The question remaining is, how do I select the appropriate funds to create a successful portfolio that is diversified among different asset classes? Start by looking at the investment objective of the fund. For example, a fund designed to track the performance of the Standard & Poor’s 500 Index would be a good fit for the U.S. large cap portion of your portfolio. Next examine the strategy of the fund. Typically passive funds that are designed to match the benchmark index have much lower cost associated with them than do actively managed funds where the manager is trying to beat a particular market. Finally be sure to check the expense ratio which includes management fees, marketing fees, other expenses, and annual operating expenses of the fund. Two funds may be managed identically to one another, yet, one could have significantly higher fees.

Regardless of your investment strategy, it’s essential that you reduce your risk exposure by diversifying among different asset classes. Develop a strategy that is aligned with you and your future, and stick to it. Having said that, don’t be afraid to make changes as you mature and your responsibilities change. Review you asset allocation annually and rebalance as necessary, but avoid trying to build the perfect portfolio. Barring any major life changes, most of us should only need to overhaul their asset allocation every 5 or 10 years.