2020 Election: Politics, Portfolios and Planning

What should investors consider as the election nears? Learn more about possible election outcomes, tax law changes and strategies from both a portfolio and planning perspective.

Key Takeaways

  • Unique election cycle, but history may be able to provide some perspective
  • Plan now to mitigate the impact of potential tax policy changes
  • Don’t let politics unduly influence investment decisions
  • Our active approach to managing all aspects of wealth can help you navigate this election season

As far as election years go, 2020 is already one to remember. With our country still recovering from the recession caused by the unprecedented COVID-19 pandemic, restarting the economy will be a major focus for whoever wins.

Ahead of Election Day, it is important to understand what history tells us about elections and to consider how potential policy changes could impact you and your wealth. But it is also important to plan for what we know and resist the temptation to let politics unduly influence investment decisions.

Elections and the Market

The U.S. stock market has done a fairly good job of predicting who will win presidential races going back to 1936. The general rule states that if the S&P 500 is positive in the three months leading up to the election, the incumbent party wins the White House. If the opposite is true, a change in presidential leadership is foreshadowed. Since we are fewer than three months away from the election, we can get an early indication of what equities may be signaling. Since August 3, the S&P 500 is up approximately 3%, having delivered the fastest recovery from a bear market of 30% or more. Historically the stock market is positive in August and doesn’t make a decisive move until September. Therefore, it will be important to watch the direction of U.S. equities over the coming weeks.  

Possible Election Outcomes

While policy platforms can influence the direction of the economy, what ultimately gets passed depends a lot on the makeup of Congress. Currently, the latest betting odds show that Democrats have a slightly greater chance of winning the majority in the Senate. A “blue wave” where Joe Biden wins the presidency and the Democrats win the House and Senate could result in the most significant policy shift, with potentially more fiscal spending and sweeping tax changes. While this scenario raises the most concern among investors, it isn’t cause for panic; with the economic recovery a top priority, new tax policies may take longer to implement or could get watered down. And while equities may react negatively at first, they could fare well over a longer time period. 

A divided government, with Biden becoming president and the Republicans retaining a majority in the Senate, would likely focus policy on infrastructure spending, more regulation and expanded health care coverage. Although Biden has proposed increasing taxes on the highest wage earners and corporations, progress on this front may be limited under a divided government. In this scenario, the equity market reaction may be muted as we believe markets are already beginning to price in some chance of a Biden win.

If President Trump wins a second term, we will likely see a continuation of his pro-growth policies, bilateral trade agreements including his “tough on China” policy and a continuation of current tax rates. This outcome could be modestly positive for equity markets.

Although markets tend to like split governments, as illustrated below, a single party in power can be positive for markets, too. Often what happens when one party controls the White House and Congress is that the party not in power gets voted back in during the midterm elections.

Planning for Potential Tax Law Changes

While President Trump’s focus would be to make some of the changes of the Tax Cuts and Jobs Act of 2017 that are expiring at the end of 2025 permanent, Biden’s tax plan proposal is more progressive. Depending on the outcome of the election, these potential changes could have a significant impact on your wealth. Let’s take a look at key areas of Biden’s tax plan (illustrated below) and a few early action items you can consider from a planning perspective ahead of potential tax law changes.

While Biden has pledged no income tax increases for individuals earning less than $400,000, those who earn above that amount could see their marginal tax rate increase to 39.6%. Meanwhile, capital gains and dividends tax rates could shift from a maximum of 23.8% to a maximum of 43.4% for taxpayers with income above $1 million.

In terms of investment portfolios, the importance of tax-aware investing, which focuses on helping to maximize after-tax returns, only increases in a higher tax environment. If you are in the process of rebalancing portfolios or paring back concentrated positions, working in consultation with your wealth manager, it may be better to take those gains in 2020. Additional planning strategies focus on how to mitigate taxes in the future. You may want to convert a traditional IRA to a Roth IRA in order to pay taxes today and avoid paying higher taxes in the future. Or, you may want to transfer appreciated assets to family members in a lower tax bracket.

Estate and gift tax is another important area of focus as the proposed changes are significant. Currently, the federal estate/gift exclusion allows individuals to give away $11.58 million of assets ($23.16 for married couples) over their lifetime or at the time of death (with amounts greater subject to a 40% tax). This exemption level could potentially decrease to $3.5 million per individual (and a 45% tax for amounts above that level). In addition, Biden has proposed the elimination of the “step-up” in basis, which adjusts the cost basis of property transferred at death to its fair market value for your heirs.

It may be prudent to use this exemption in 2020 before a potential reduction in 2021. If you don’t want to make a gift outright but want access to those funds, consider transferring assets to a trust. Trusts can be structured to provide access to your spouse in the event that you need to use the trust assets in the future. Also, to minimize the future tax impact on your heirs, you may want to consider selling highly appreciated assets today and pay the 23.8% (as opposed to 43.4% later) or transferring low basis assets to charity.

A Call to Action – Not Overreaction

Elections can often bring about volatility and emotion. That said, it is important not to allow election turbulence to overly influence your investment decisions. Instead, it is best to stick with a long-term investment strategy aligned with your goals.

We have not made any asset allocation changes based solely on an expected election outcome. Rather, market fundamentals inform our shifts in positioning. We recently recommended a modest reduction to our domestic large cap equity allocation in order to realize gains and reallocate to non-U.S. equities. Factors such as a weakening dollar, signs of a faster recovery outside the U.S. and attractive relative valuations led to this decision; not who might win the White House. However, we are making buy and sell stock decisions, with our equity analysts uncovering bottom-up opportunities based on the expected winners and losers of each candidate’s policy platform.

A lot will happen between now and November. As always, our goal is to provide proactive advice on all aspects of your wealth. It is important to consider taking steps today to mitigate the potential impact of higher taxes on your portfolio, wealth and estate plans. We are here to help ensure that you are well positioned for every market cycle and the eventual political and policy environment.

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