Five Key Points
- Markets Go Up: Over the past 42 years, the stock market has gone up about 80% of the time, regardless of which political party is in power.
- Taxes Tend to Rise: Tax rates typically increase following economic downturns and as economies recover.
- Loopholes Abound: Even with targeted tax increases, history shows that loopholes and workarounds often emerge.
- Focus on Long-Term Goals: Don't let short-term political volatility derail your long-term financial plan.
- Stay Calm and Invest On: Maintain a steady investment strategy, focusing on low-cost index funds and consistent contributions.
This is not a political post about who to vote for, nor is it meant to incite fear or panic about the potential election outcome. The sad reality is that by Wednesday morning next week, November 6th, nearly half of America will wake up feeling like they've lost.
This article is an attempt to ease election-related anxieties and help keep the results in perspective regarding your finances, regardless of who wins. Even if your preferred party loses, it won’t be the end of the world or lead to economic catastrophe, despite the extreme political scare ads (I live right next to a swing state, so I'm no stranger to them).
Looking at the numbers, investors should approach the results with a more tempered outlook. For long-term investors focused on retirement, which party holds the White House historically hasn’t made much difference.
I know, I know: “But everything is going to change!” “Taxes will go up!” “The world is coming to an end!” “We need cryptocurrencies to save ourselves!” “I don’t look good in that color!” I hear this a lot.
Understandably, taxes and their effect on investments are the top concerns of most clients. The sad truth is the probability of tax increases over the next four years is high under either candidate. COVID-era stimulus spending, among other expenses, will eventually need to be paid for. Additionally, the United States will need to address its decaying infrastructure and other pressing needs if we want to keep up with countries like China. But even if taxes do go up, history shows that as taxes increase, so do tax loopholes.
When One Door Closes, Another One Opens
Generally, no politician advertises tax increases across the board for all citizens; it would be a terrible political move. Instead, they frame tax hikes as targeted toward specific groups, like high earners, corporations, or multinationals. But when these tax increases are implemented, they often come with numerous loopholes and workarounds, so it’s crucial to consider the net effect.
The Urban-Brookings Tax Policy Center has compiled data on total average tax rates between 1979 and 2020, reflecting federal income taxes paid by individuals, payroll, corporate, and excise taxes divided by total gross income. This metric gives a more realistic picture than simply looking at marginal tax rates as a percentage of taxable income, which may seem higher. By dividing actual taxes paid by gross income, we capture the impact of various tax loopholes. The downside to this data is that it takes time to gather, so the latest information only goes up to 2020 and doesn’t include the most recent administration.
Most of my readers and clients fall into the highest quintile, the top 25%, but the overall combined tax rate is a more accurate rate for the effect on the total economy. The data shows that the total tax rate tends to rise under Democratic leadership and fall under Republican leadership. Interestingly, prior to Trump’s tax cuts, both the highest combined rate (23.1% under Clinton) and the lowest rate (17.9% under Obama) occurred under Democratic leadership.
Notably, all significant tax rate reductions have been associated with economic downturns—1981’s Black Monday, the Dotcom Crash in the early 2000s, the Great Recession of 2008-09, and the COVID crisis. As economies recover from these crises, the trend has generally been to gradually increase taxes, even during the Reagan/Bush era, often regarded as a low-tax period in U.S. history.
Based on this data, unless another crisis arises it’s logical to expect a tax increase under either candidate. The real question is, what does this mean for your investments?
Investment Impact
By dropping the highest quintile tax rate from view to declutter the graph and adding in the S&P 500 annual returns, a few things stand out.
First, President George W. Bush faced challenging financial markets at both the beginning and end of his tenure—the Dotcom Crash followed by the Great Recession. Maybe he could have used a bit more "strategery" (no shade intended—just an excuse to throw in some classic SNL).
There also does not seem to be any correlation between market returns and stock market returns. The best preforming market period, 1995-1999, was also during a period of increasing tax rates under Clinton. Running statistical analysis also confirms this weak correlation with a Pearson correlation coefficient between the tax rate and S&P 500 annual returns of approximately 0.108, with a p-value of 0.494. This low correlation indicates a weak positive relationship between the two variables, but the p-value suggests that this result is not statistically significant.
In practical terms, this means there is no strong or reliable relationship between tax rates and S&P 500 returns in this dataset. Changes in tax rates do not appear to have a predictable impact on S&P 500 returns based on this data alone.
The Smart Bet
Another striking feature is the prevalence of positive-return years compared to negative-return years. Between 1979 and 2020, there were 33 years of positive returns and only 9 years of negative returns. Over this period, markets delivered positive returns 78.6% of the time. Here’s a breakdown of returns, positive and negative, by party:
This raises a crucial question for investors: how should you use this information? Consider this: if you had the opportunity to make a bet with a 79% chance of winning, wouldn't you take it? This data provides compelling evidence for investing in the market, regardless of the current political climate. Remember this insight, especially when political headlines create uncertainty. Markets have historically endured, irrespective of which party holds power.
Granted, a deeper analysis would involve looking at the control of Congress alongside the presidency, as both are needed to drive tax policy. Accounting for external shocks like pandemics would also add precision, though these remain unpredictable. What we do know from the past 42 years, including the so-called "lost decade" from 2000 to 2010, is that 79% of the time markets have risen over the year. If you’re betting, bet on the market going up this year too.
Spend less than you make, invest the difference in low-cost index funds, be kind to neighbors (red and blue alike), and you'll succeed in reaching your financial goals while making the world around you a little brighter. Don’t let politics drive a wedge between you and your loved ones—it’s not worth it.
At Purpose Built, we're committed to helping families like yours make informed decisions that align with your financial goals. Let's work together to turn the stress of elections into a manageable and even empowering experience.
Your financial well-being is too important to leave to chance. Choose wisely.
FAQ
Q: Should I change my investments based on who wins the election?
- A: Generally, no. History suggests that market performance is not strongly correlated with which party controls the White House. Sticking to a well-diversified, long-term investment strategy is usually the best approach.
Q: Will my taxes definitely go up?
- A: While it's impossible to predict the future with certainty, the historical trend indicates a high probability of tax increases in the coming years, regardless of who wins the election.
Q: How can I protect my investments from potential tax increases?
- A: Work with a qualified financial advisor who can help you navigate potential tax implications and adjust your investment strategy accordingly. Consider tax-efficient investment vehicles and strategies.
Q: What if the election results cause a market downturn?
- A: Market downturns are a normal part of the investment cycle. Remember that the market has historically recovered from every downturn. Try to avoid making emotional decisions and stay focused on your long-term financial goals.
Final Thoughts
Ready to take control of your financial future and navigate the uncertainties ahead? Schedule a meeting today to discuss your financial goals and how Purpose Built can help you achieve them.
Let's get started—schedule a call today.
About the Author
Sean Lovison, CPA, CFP®, is a flat fee-only financial planner based in Moorestown, New Jersey, serving clients virtually nationwide. After spending 14 years as a corporate chief financial officer (CFO), receiving and designing compensation plans, he decided to help others navigate their plans.
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