Investing Through Political Turbulence: A Guide for Election Years

The upcoming presidential election has stirred up a unique blend of hype, anxiety, and speculation, creating uncertainty for investors. The financial world braces for potential ripples as candidates make bold promises and voter sentiment shifts. We’ll examine how presidential elections historically affect the stock market and provide insights to help investors navigate this turbulent period.

Investors are particularly concerned about the election’s potential impact on the economy and stock market, given the current socio-political polarization that extends beyond electoral politics. Issues such as foreign policies, immigration, and budget allocation add to the situation’s complexity, making it difficult to predict how these factors will ultimately affect the markets.

The Stock Market and Presidencies
S&P 500 price returns on a log scale with presidents and their parties highlighted since 1933

Historical Insights: Presidential Terms and Market Performance

Despite the significance of elections, it’s crucial for investors to base their decisions on sound financial planning rather than being swayed by the political climate. Emotional judgments and political biases should be set aside in favor of a rational approach. During their terms from 2008 to 2020, Presidents Obama and Trump faced numerous challenges, including budgetary conflicts, debt ceiling crises, fiscal cliff standoffs, U.S. credit rating debacles, and major global events like the financial crisis and the COVID-19 pandemic. Despite their differing administrative approaches, the S&P 500 saw a substantial increase in total returns of 236%. However, this growth cannot be attributed solely to government policies; industries and firms also played a role by adapting to market changes triggered by government actions.

Presidents and Stock Market Returns
S&P 500 price returns and averages over presidential terms since 1933

Analyzing Policy Impact on Economic and Market Dynamics

Evaluating the impact of policy changes on the economy and markets has historically proven erratic. Tax laws, industrial activities, trade associations, and antitrust can significantly transform specific sectors, influencing the broader economic structure. Companies and sectors consistently moderate their strategies based on new policies introduced.

Regardless of which party controls the White House, the S&P 500 has commonly returned double-digit growth. Positive market returns are a historical norm, and investors should maintain a balanced approach to benefit in the long term beyond the emotions of an election year.

Presidential Elections and Stocks
S&P 500 total returns by presidential party Returns during presidency and lagged one year since 1933
Disclaimer
The content on this site, provided by Able Wealth Management, is purely informational. While we aim for accuracy and completeness, we cannot guarantee the exactness of the information presented. The views and analyses expressed in this blog represent those of the authors at Able Wealth Management. They should not be considered as investment advice or endorsement of any particular financial instrument or strategy. Any references to specific securities and their performance are purely informational and should not be taken as advice to buy or sell.Before implementing any information or ideas presented, we strongly advise consulting with a financial advisor, accountant, or legal counsel. Investing carries inherent risks, including potential capital loss. Asset values can fluctuate over time and may be worth more or less than the original investment. Past performance does not guarantee future results, and Able Wealth Management cannot ensure that your financial goals will be achieved. Information from third-party sources has not been independently verified by Able Wealth Management. Although we trust these sources, we cannot assure their accuracy or completeness.

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Volatility Drag

Volatility drag, often unnoticed by many investors, plays a significant role in the performance of investment portfolios, especially in markets characterized by high volatility. Understanding volatility drag is crucial for making informed investment decisions and managing long-term investment performance.

Understanding Volatility Drag

Volatility drag refers to the negative effect of investment volatility on compound returns over time. It occurs because losses have a more significant impact on portfolio value than gains of the same magnitude. For example, if an investment loses 10% one year and gains 10% the next, the investment will not return to its starting value due to the mathematical asymmetry between gains and losses. This phenomenon underscores the importance of minimizing large fluctuations in investment value to protect long-term returns.

The Mathematics Behind Volatility Drag

The mathematical principle underlying volatility drag is relatively straightforward but profound in its implications for investors. The key concept is that percentage gains and losses are not symmetrical. A 50% loss requires a 100% gain to break even, not a 50% gain. This asymmetry means that volatility (up and down movements in price) can erode the compound growth rate of an investment, even if the arithmetic mean of the returns seems healthy.

Example of Volatility Drag

Consider an investment with the following annual returns: +20%, -15%, +10%, and -5%. While the arithmetic mean of these returns might suggest a modest positive performance, the compound annual growth rate (CAGR) would tell a different story, factoring in the volatility drag and showing a lower effective return than the arithmetic mean would suggest.

Implications for Investors

  • Risk Management: Understanding volatility drag emphasizes the importance of risk management strategies, such as diversification and the use of derivatives for hedging, to minimize significant downturns in portfolio value.
  • Investment Strategy: Investors might consider investment strategies that aim for steady, consistent returns over those with potentially higher but more volatile returns. Such strategies might include investing in low-volatility stocks, index funds, or using dollar-cost averaging to mitigate the impact of market fluctuations.
  • Psychological Aspects: Volatility drag also highlights the psychological challenge for investors who may overreact to short-term market movements. A long-term perspective is crucial for successful investing, as frequent trading in response to volatility can exacerbate the drag on returns.
  • Performance Evaluation: When assessing investment performance, considering both the arithmetic mean return and the compound annual growth rate (CAGR) can provide a more comprehensive view of an investment’s performance, factoring in the effect of volatility.

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