This year's presidential election has been especially polarizing, and political events can sometimes influence the stock market. Stock market volatility tends to increase in presidential election years, especially in the 100 days leading up to the election, according to Vanguard research going back to 1853. However, presidential elections don't typically have a long-term impact on market performance, and the markets tend to stabilize in the 100 to 200 days after the election, Vanguard found.
[Read: 5 New 401(k) and IRA Rules for 2017.]
The Vanguard data appears to show that financial markets are generally politically agnostic, and stock market returns do not differ significantly under Democratic and Republican administrations. So, don't make investment decisions based on the political party in power. Here's how to sort through the sensational political headlines and determine a prosperous path forward to protect your financial and retirement goals.
Don't let your political fears cause you to make long-term mistakes. Presidents and other elected officials serve for a limited period of time, which is usually four or eight years in the case of the presidency. If you have short-term cash flow needs (up to five years) that could be impacted by volatility resulting from this election cycle, the assets used to fund those needs should be kept in lower-risk, liquid investments such as savings accounts, CDs and money market funds. This will make sure your immediate needs are met even if there are election-related swings in the stock market.
However, your long-term needs and goals, such as retirement savings and financial independence, can continue to be funded through a risk-adjusted diversified portfolio. It could actually be detrimental to your long-term success if you quit contributing and investing for retirement just because of a presidential election or fears arising from that event. Pulling your money out of the stock market in a panic will also cause you to miss the subsequent growth during the recovery.
Create a financial plan to protect you from the scenarios you fear. An elected official's political affiliation does not predict the direction of markets or portfolio returns. The financial markets are impacted by much larger components of the economy including technology, innovation, demographics, the policies of the Federal Reserve and large scale events such as wars and natural disasters. Many of these items are outside of your control, so the best course of action to protect your family is to create a financial plan for the events you can control. The sensational coverage of the election can awaken financial insecurities that may or may not be warranted. Below are a few of the fears that you can face head on and prepare for:
Prepare for the possibility of job loss. If you're worried about losing your job, keep enough savings in cash to cover your bills for the period of time you think it will take to find a new position. Typically, you should have 3 to 6 months of cash reserves on hand.
Make sure your family will be provided for if you die. Death and disability are two of the scariest scenarios you could face. If you're worried about what would happen if you weren't there to provide for your family, consider purchasing disability insurance that can cover at least 60 percent of your current income and term life insurance to protect your family and replace your income in the event of your death. This is a far scarier scenario than anything the presidential election will do to your investments.
Diversify your portfolio. If you're worried about the volatility of the financial markets, diversification can help. It's difficult to watch the value of your life savings fluctuate due to events beyond your control. For example, the S&P 500 declined sharply following the Brexit vote, but then climbed back up again a few days later. If your investments are spread across a mix of cash, bonds, stocks and real estate, you are much more likely to stay on course and not make an emotional mistake that could short change your long-term goals.
The next President of the United States is uncertain, and financial markets do not like uncertainty. But we are close to deciding who the next president will be. Make sure you can separate the fact and fiction on how the election will impact your financial life. Many of the fears we all face from elections can be mitigated if we make sure our financial houses are in order and we are protected no matter what scenario we face.
Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".