Navigating Market Volatility: Common Investor Mistakes During Election Years
The last month has been a whirlwind for the financial markets. Investors have been hit with a series of unsettling developments, from disappointing Q2 reports from major tech companies to uncertainty around short-term interest rates following remarks from Federal Chair Powell. On top of that, international markets, particularly Japan, have added to the confusion, all while the upcoming election looms large. Despite these challenges, there’s a silver lining: stock prices have shown resilience, with the market beginning to shake off the turbulence of August. As we move closer to election season, it’s crucial for investors to stay focused on the long-term, avoiding the pitfalls that often arise during these politically charged times. In anticipate of the upcoming elections, we wanted to share a piece that Capital Group recently published highlighting the 3 mistakes that investors make during election years.[1]
Mistake #1: Investors worry too much about which party wins the election
There’s nothing wrong with wanting your candidate to win, but investors can run into trouble when they place too much importance on election results. That’s because elections have, historically speaking, made essentially 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 Capital Group 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 $1,000 investment in the S&P 500 Index made when Franklin D. Roosevelt took office would have been worth almost $22 million today. During this time, there have been eight Democratic and seven Republican presidents. Getting out of the market to avoid a certain party or candidate in office could have severely detracted from an investor’s long-term returns.
By design, elections have clear winners and losers. But the real winners were investors who avoided the temptation to base their decisions around election results and stayed invested for the long haul.
Stocks have trended higher regardless of which party has been in office
Sources: Capital Group, Morningstar, Standard & Poor’s. As of 31 December, 2023. Dates of party control are based on inauguration dates. Values are based on total returns in USD. Shown on a logarithmic scale. Past results are not predictive of results in future periods.
Mistake #2: Investors get spooked by primary season volatility
Markets hate uncertainty, and what’s more uncertain than primary season of an election year? That said, volatility caused by this uncertainty is often short-lived. After the primaries are over and each party has selected its candidate, markets have tended to return to their normal upward trajectory.
Markets often bounce back after the volatility of primary season
Election year volatility can also bring select buying opportunities. Policy proposals during primaries often target specific industries, putting pressure on share prices. The health care sector has been in the crosshairs for a number of election cycles. Heated rhetoric over drug pricing put pressure on many stocks in the pharmaceutical and managed care industries. Other sectors have had similar bouts of weakness prior to elections.
Does that mean investors should avoid specific sectors altogether? Not according to Rob Lovelace, an equity portfolio manager with 38 years of experience investing through many US election cycles. “When everyone is worried that a new government policy is going to come along and destroy a sector, that concern is usually overblown,” Lovelace says.
Regardless of who wins, stocks with strong long-term fundamentals will often rally once the campaign spotlight fades. This pre-election market turbulence can create buying opportunities for investors with a contrarian point of view and the strength to tolerate short-term volatility.
Mistake #3: Investors try to time the markets around politics
If you’re nervous about the markets in 2024, you’re not alone. Presidential candidates often draw attention to the country’s problems, and campaigns regularly amplify negative messages. So maybe it should be no surprise that investors have tended to be more conservative with their portfolios ahead of elections.
Since 1992, investors have poured assets into money market funds — traditionally one of the lowest-risk investment vehicles — much more often leading up to elections. By contrast, equity funds have seen the highest net inflows in the year immediately after an election. This suggests that investors may prefer to minimize risk during election years and wait until after uncertainty has subsided to revisit riskier assets like stocks.
Investors have tended to be more cautious leading up to elections
Sources: Capital Group, Morningstar. Values based on USD. Equity funds include US and global ex-US equity funds.
But market timing is rarely a winning long-term investment strategy, and it can pose a major problem for portfolio returns. To verify this, we analyzed investment returns over the last 23 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. We 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 17 of 23 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.
Conclusion
As we navigate through the election cycle and anticipate potential interest rate cuts, it’s important for investors to keep their emotions in check and avoid common mistakes. Historical data shows that staying invested, even during periods of heightened uncertainty, is typically the best strategy. While market volatility is likely to persist, especially as political campaigns heat up, maintaining a disciplined, long-term approach can help investors weather the storm and achieve their financial goals. The key takeaway? Don’t let short-term political noise derail your long-term investment strategy.
[1] Lovelace, Rob and Spencer, Darrell. “Three Mistakes Investors Make During Election Years.” Capitalgroup.com March 7, 2024. https://www.capitalgroup.com/intermediaries/nl/en/insights/articles/3-investor-mistakes-election-year.html
Past results are not predictive of results in future periods.
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