Many people have asked me in recent weeks whether they should be making changes to their investment portfolios as a result of recent developments in the presidential election.
Some have raised the question because, as Donald Trump’s chances of winning tomorrow’s election have improved since mid October (from roughly 15% to as high as 35%), stock markets have declined (roughly 3%) over the same period. Moreover, during a recent National Public Radio interview with a couple of academic economists, it was suggested that stocks could sell off as much as 15% if Trump is elected.
Others have wondered if portfolios should be adjusted because of the possibility of social unrest and potential ongoing political gridlock that could follow a Clinton victory.
Whatever their political persuasion, they are typically dissatisfied with my answer, which is “It depends.”
So here are some thoughts that can help you assess whether the uncertainty around the election should trigger changes to your investments.
In short, if your investments (a) are appropriately diversified and (b) subject you to no more short-term losses than your emotions and need for cash can handle, then you may not need to make any changes. However, if you are not sure whether you meet this two-pronged test, then you should use Election Day anxieties as an overdue prompt to evaluate your investment strategy and consider making adjustments.
There are two simple reasons — one long-term and one short-term —that you may not need to make any changes if you are sure your investment portfolio passes my test. It starts with understanding the fundamental reason that stocks increase in value — namely, long-term growth in corporate profits. Though stocks may slump and stall for a while if Trump is elected due to uncertainty, his ensuing policies and pronouncements are not likely to produce a meaningful reduction in the long-term profits of publicly-traded corporations. Indeed, there are substantial portions of the market (e.g.energy and health care stocks) that may rise if Trump is elected.
Some of you may think they are smart enough to make money trading into major geo-political developments, even though research suggests that approach is likely to fail. But you have to wonder about the wisdom of betting against a result that experts say has a 65%-85% likelihood of occurring (i.e. a Clinton victory) — a development that will likely result in a short-term increase in stock values.
On the other hand, readers who are unsure if their portfolios are sufficiently diversified and would provide enough protection against dropping markets should ask themselves whether their investments are sufficiently designed to “expect the unexpected” from geo-political developments. If not, use this as a call for action.
One way to assess this is to estimate how much your current portfolio would have dropped during the Great Recession back in 2008-09, when stocks on average dropped over 50%.
For example, consider what might happen if you have 80% of your portfolio invested in stocks, which is not an uncommon allocation. If a 40% decline in the value of your portfolio would cause financial problems, such as forcing you to sell stocks when they are low to raise cash needed to support your lifestyle, or cause lost sleep at night, then you should use the uncertainty of this specific geo-political event to adjust the risk and return attributes of your investment portfolio. Consider for instance, increasing your allocation to investments (e.g.U.S. government bonds or funds that “short” the stock market) that will do relatively well during market sell-offs.
How much is enough to have in more stable investments — those that do relatively well during periods of anxiety — depends on your specific situation. For instance, if you rely on distributions from your investments to support your lifestyle, you might want to have several years’ worth of distributions in securities expected to hold their value during stock market declines. Similarly, whether or not sharp drops in stock market values threaten your day-to-day financial cash flow needs, you should also consider increasing your allocation to more stable investments if short-term volatility creates such psychological stress that it interferes with your peace of mind,, foregoing some upside growth potential for the sake of greater stability.
There are other ways to decrease downside risk by assessing how you have structured the portion of your investments allocated to stocks. For instance, make sure you do not have too much allocated to certain companies or industry sectors that might be adversely affected by shifts in political winds. You may also want to focus on stocks that have produced consistent earnings growth, allocating less into stocks that have greater fluctuations in earnings.
The ultimate effect of these and other strategies to insulate yourself from the ever-present risk of political surprises is that your portfolios should do better than average in declining markets. This also means, however, that when markets roar up, your portfolio will generally grow at a more moderate pace. If this trade-off sounds good to you, you may want to move now, while stocks are still close to all-time highs.
In summary, this unusually contentious election season may produce more short-term stock market volatility and psychic distress than usual. If you are sure your investments already have enough in relatively stable investments to avoid financial or emotional stresses in the event of post-election declines following the election, then you can probably worry about other aspects of the election beyond your investment portfolio.
If not, consider the election to be a call for action to take better care of your own financial future, even as you contemplate the impact of Election Day on our country as a whole.