It’s almost Election Day in the US once again. For those who need a brief civics refresher, every two years the full US House of Representatives and one-third of the Senate are up for reelection.

While the outcomes of the elections are uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the days to come. In financial circles, this will almost assuredly include any potential for perceived impact on markets. But should long-term investors focus on midterm elections?

MARKETS WORK

We would caution investors against making short-term changes to a long-term plan to try to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the aggregate expectations of those investors. This makes outguessing market prices consistently very difficult. While surprises can and do happen in elections, the surprises don’t always lead to clear-cut outcomes for investors.

The 2016 presidential election serves as a recent example of this. There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected. The day following President Trump’s win, however, the S&P 500 Index closed 1.1% higher. So even if an investor would have correctly predicted the election outcome (which was not apparent in pre-election polling), there is no guarantee that they would have predicted the correct directional move, especially given the narrative at the time.

But what about congressional elections? For the upcoming midterms, market strategists and news outlets are still likely to offer opinions on who will win and what impact it will have on markets. However, data for the stock market going back to 1926 shows that returns in months when midterm elections took place did not tend to be that different from returns in any other month.

Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926–August 2018. Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%). The blue and red horizontal lines represent months during which a midterm election was held, with red meaning Republicans won or maintained majorities in both chambers of Congress, and blue representing the same for Democrats. Striped boxes indicate mixed control, where one party controls the House of Representatives, and the other controls the Senate, while gray boxes represent non-election months. This graphic illustrates that election month returns were well within the typical range of returns, regardless of which party won the election. Results similarly appeared random when looking at all Congressional elections (midterm and presidential) and for annual returns (both the year of the election and the year after).

Exhibit 1.       Midterm Elections and S&P 500 Index Returns, Histogram of Monthly Returns
January 1926–August 2018

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. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

IN IT FOR THE LONG HAUL

While it can be easy to get distracted by month-to-month or even one-year returns, what really matters for long-term investors is how their wealth grows over longer periods of time. Exhibit 2 shows the hypothetical growth of wealth for an investor who put $1 in the S&P 500 Index in January 1926. Again, the chart lays out party control of Congress over time. And again, both parties have periods of significant growth and significant declines during their time of majority rule. However, there does not appear to be a pattern of stronger returns when any specific party is in control of Congress, or when there is mixed control for that matter. Markets have historically continued to provide returns over the long run irrespective of (and perhaps for those who are tired of hearing political ads, even in spite of) which party is in power at any given time.

Exhibit 2.       Hypothetical Growth of $1 Invested in the S&P 500 Index and Party Control of Congress
January 1926–August 2018

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. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

Equity markets can help investors grow their assets, and we believe investing is a long-term endeavor. Trying to make investment decisions based on the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, to pursue investment returns.

PRINCIPLE #8 IS HERE!

Do Emotions affect Investment Returns!

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Many people struggle to separate their emotions from investing. The chart above shows the correlation between emotional cycles and market returns. Investors typically buy at “Elation” and sell at “Fear”, inherently creating a dreaded “selling low, buying high” strategy.

A philosopher once said that nothing is as difficult for people as not deceiving themselves. But while most self-delusions are relatively costless, those relating to investment can come with a hefty price tag.

Market volatility in 2008 and 2009 took investors on a bumpy, emotional ride. Despite the market’s strong performance after March of 2009, many investors were too exhausted to endure the ongoing stress of an uncertain economy and market. By making an emotional decision to avoid the stress, there are millions of investors who never recovered their losses and sacrificed the enormous gains that would follow.

On the contrary – prior to the tech bubble of the early 2000’s, investors were pumping money into the dot coms because they saw their neighbor or co-worker getting rich. Driven by media and emotional investing, American’s poured their savings into tech stocks, only to endure the bubble bursting in 2000.

Some media outlets claim a similar bubble for tech stocks in ‘15 and ‘16. A Bing search on this claim literally pulled up the following article titles, one after another on page 1:

“Why this Tech Bubble is Worse than the Tech Bubble of 2000”

“Why this Tech Bubble is Less Scary than the Tech Bubble of 2000”

Magazines sell by appealing to the emotions of a reader. When it comes to investments, reacting to what you read or see on TV can be detrimental to your long-term retirement plan. Keep these tips in mind before making an emotional investment decision:

1. Market timing is hard.
2. Never forget the power of diversification.
3. Markets and economies are different things.
4. Discipline is rewarded.

Overcoming self-deception is not impossible. It just starts with recognizing that, as humans, we are not wired for disciplined investing. We will always find one way or another of rationalizing an emotional reaction to market events. But that’s why even experienced investors engage advisors who know them, and who understand their circumstances, risk appetites, and long-term goals. The role of your advisor is to listen to and acknowledge your very human fears, while keeping us in the plans we committed to at our most lucid and logical moments. Can you say with confidence that your investment decisions are based on a long-term strategy, or are your current emotions playing a role?

PRINCIPLE #7 IS HERE!

AVOID MARKET TIMING!

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You never know which market segments will outperform from year to year. By holding a globally diversified portfolio, investors are well positioned to seek returns wherever they occur. Trying to correctly time your entry point to the market is difficult, and unfortunately humans have an instinctive desire to take control and make a change when things aren’t moving in the direction we want.

The problem is that what appears to be an intelligent alternative may actually be a distraction. Remember, hindsight is twenty-twenty. There are always short-term investments that do better than a balanced portfolio, but chasing returns is dangerous. What works is having a successful investment strategy and the discipline to stick with it.

Market timing is a seductive strategy. If we could sell stocks prior to a substantial decline and hold cash instead, our long-run returns could be exponentially higher. But successful market timing is a two-step process: determining when to sell stocks and when to buy them back. I can think of a couple of examples where getting these two key things correct would have been extremely difficult and maybe even impossible.

First, leading up to the presidential election in 2016, everyone predicted that a victory for Donald Trump would send the stock market into a tailspin. Nearly every media outlet predicted a market crash if Trump won, and many investors took the advice and withdrew. Yet after some brief jitters following Trump’s win, the stock market kept marching skyward. By the time Trump clinched the presidency, the market rallied and closed the trading day 256 points higher.

And let’s not forget the Brexit news of a couple of summers ago. Wasn’t Britain’s exit from the European Union finally the trigger of the next Stock Market crash? If you read the headlines and listened to the noise, you may have sold your stocks that June when the DJIA was just over 18,000. Four days after Brexit, the market stabilized and began its steady incline.

So how do we get our egos and emotions out of the investment process? One answer is to distance ourselves from the daily noise by appointing a financial advisor to help stop us from doing things against our own long-term interests. Investment advice is not about making predictions about the market. It’s about education and diversification and designing strategies that meet the specific needs of each individual. Ultimately it’s about saving investors from their own, very human, mistakes. What often stops investors from getting returns that are there for the taking are their very own actions—lack of diversification, compulsive trading, buying high, selling low, going by hunches and responding to media and market noise.

An advisor begins with the understanding that there are things we can’t control (like the ups and downs in the markets), and things we can (like proper diversification, rebalancing, minimizing fees, and being mindful of tax consequences). Most of all, an advisor helps us all by encouraging the exercise of discipline—the secret weapon in building long-term wealth.

Working with markets, understanding risk and return, diversifying and portfolio structure—we’ve heard the lessons of sound investing over and over. But so often the most important factor between success and failure is ourselves. Do you have a plan for navigating the “media noise”, and avoiding the temptation to time the market?