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Election 2012: What's at Stake
The charged rhetoric of a presidential campaign can rattle many investors--and the markets. That's why it's important to know what's really on the line, and the steps you might take to prepare for what's ahead
Most voters would probably agree that the two major candidates running for president of the United States, Barack Obama and Mitt Romney, offer distinctly different visions for the U.S., and that the choice we make in November could have a profound effect on our country's long-term economic life. Republicans and Democrats are working hard to mark the differences between what each party has to offer. What's more, it looks like this election is going to be a close one, making it all the more difficult for investors--and the markets--to predict which of the two visions will prevail.
At the same time, some economic and political observers believe that no matter who wins, the results are unlikely to matter nearly as much as the rhetoric suggests. "Regardless of the outcome, gridlock and partisanship are likely to prevent most really ambitious policy changes," says Sean West, head of United States Practice at Eurasia Group.
Where exactly does this leave investors? Will the election bring significant change or a continued status quo? And what, if any, investment moves should you be considering in the meantime? It may not make much sense to suspend all of your important financial decisions until a clear winner arrives in November. To provide some context on the elections, Advisor magazine has asked some of the top thinkers at and outside Merrill Lynch for insights on some of the issues most likely to affect our financial lives, now and in years to come.
THE FISCAL CLIFF
What to know: Talk of a fiscal cliff started last year, when Congress passed a law to increase the federal debt ceiling. As part of that bill, a congressional "super committee" was charged with reaching a bipartisan agreement on deficit reduction. Because the super committee did not succeed, $1.2 trillion in automatic spending cuts are now scheduled to go into effect on Jan. 1, 2013. Those reductions, in combination with tax increases, could slow business hiring and investment while leaving consumers strapped for cash. "The fiscal cliff is likely to pose a major challenge to the markets and the economy around the end of this year," says Ethan Harris, co-head of Global Economics Research at BofA Merrill Lynch Global Research. "We would expect weak growth and a choppy market."
What you can do: You're probably best served by keeping a conservative portfolio, believes Harris. "We think there's a good case for maintaining significant exposure to the stock market. In our opinion it's conservatively valued, and the return on cash is effectively zero. The corporate sector is currently in great health, and earnings and balance sheets are strong."
What you probably shouldn't do: Don't panic. Congress will still have an opportunity in a lame-duck session to pass at least short-term measures. Even if the worst happens and tax hikes for all take place immediately, spending cuts will be gradual, giving investors time to make adjustments.
TAXES
What to know: Unless Congress and the President act to amend current law, a cascade of changes to tax law will likely occur. Almost all of the cuts enacted during the past 11 years will expire, raising rates and ratcheting down exemption levels across the board. In any event, taxes likely will go up for at least the most affluent families no matter who takes office.
What you can do: Moves you can make now could result in substantial savings--such as giving away as much as you can of the $10.24 million that couples are allowed to transfer without gift- or estate-tax consequences. In addition, selling a business or a large concentrated stock position this year could potentially help you save on capital gains taxes. Lisa Shalett, chief investment officer of Merrill Lynch Global Wealth Management, suggests considering portfolio changes as well. If it's suitable for your situation, you might consider increasing holdings of tax-efficient investments such as municipal bonds in taxable accounts, while consolidating less tax-efficient investments into 401(k)s, IRAs and other accounts that let you postpone taxes until retirement. Finally, by converting a traditional IRA to a Roth this year, you could pay income tax on the conversion at today's low rates.
What you probably shouldn't do: Don't delay getting your wealth transfer strategy in place. If you want to use this year's large exemption to fund a trust, it will take time to create one that suits your purposes, notes Andrew Friedman, principal of The Washington Update and a former senior tax partner in a Washington, D.C., law firm. "Trust attorneys are already busy," he says.
VOLATILITY
What to know: Much of the U.S.'s current volatility stems from the public perception that critical domestic economic questions are not being resolved. "Every tough decision of the past few years has been pushed to this period," Harris says. Some investors will no doubt wait until after the election to see how well the newly elected president and the revamped Congress can work together. But that could mean missing opportunities to help strengthen your portfolio.
What you can do: Think long term. Investors may be best off keeping a diversified portfolio of equities and fixed income largely intact. They might also consider seeking relative stability through the "Nifty 50," a changing list of the 50 largest stocks by market cap, suggests Mary Ann Bartels, head of U.S. Technical and Market Analysis at BofA Merrill Lynch Global Research. "These large companies almost always have strong fundamentals and usually pay solid dividends," Bartels says.
What you probably shouldn't do: Don't look at your portfolio every day. Investors who are skittish may be more likely to sell prematurely if they see their investments dip. But losses could prove temporary, and many fixed-income investments that are generally considered safe might not offer much long-term growth.
INTEREST RATES
What to know: Taxes, the deficit and economic growth all affect interest rates. To the degree the election's outcome influences any of these economic issues, it's almost certain to have an impact on interest rates. U.S. rates have been at historic lows in recent years, thanks to interventions by the Fed--which is nonpartisan and operates independently of the president and Congress. That likely won't change until 2014, regardless of the election outcome. "But we need to be talking now about what happens after 2014," Shalett says. "Should inflation return, rates may go up quickly." In all likelihood, the sitting president will largely determine the policy response.
What you can do: Rising interest rates will make the lower rates of previously issued bonds less attractive, causing those bonds' prices to fall on the open market. To prepare for that possibility, you might consider emphasizing intermediate-term rather than long-term bonds. Because interest rates typically rise in tandem with inflation--which makes bond income worth less--consider upping your exposure to real assets such as real estate, gold or commodities. Their prices tend to rise whenever inflation heats up.
What you probably shouldn't do: Don't avoid municipal bonds. When taxes go up, tax-free municipal bonds become more valuable. High-quality munis remain a very reliable investment, says Martin Mauro, head of Fixed Income Strategy for Merrill Lynch Global Wealth Investment Management. "The default rates have been low on these bonds--much lower than defaults on corporate debt," he notes.
THE DEFICIT
What to know: The partisan divide on Capitol Hill means we're unlikely to see a grand bargain on deficit reduction anytime soon. But inaction doesn't necessarily mean imminent disaster, according to Sean West of Eurasia Group. "There's room for us to do nothing for a period of years and address this later, or to take small steps now," he says. "It's not a matter of 'fix everything immediately.' We have a lot more space than is commonly recognized."
Eventually the nation will have to address its trillion-dollar deficit, which could mean still higher taxes as well as cuts in the most costly government programs, such as Medicare and Social Security. Those looming, longer-range changes could figure prominently into your retirement plans, Shalett says.
What you can do: With your Financial Advisor, revisit your long-term strategies, focusing particularly on the cost of health care during retirement. If you are more than a decade away from qualifying for Medicare, which currently covers everyone beginning at age 65, look at other potential scenarios for doctor and hospital costs. "Make sure you have adequate coverage today and that you've taken into account the possibility that Medicare benefits will be reduced," Shalett says. Similarly, see to it that you have a thoughtful contingency plan in the event that Social Security benefits are reduced.
What you probably shouldn't do: Don't lose perspective. Most investors around the globe still consider the U.S. the safest haven. Having dollars flow in every time there's a global financial jolt can help reduce the cost of financing the national debt and provide many other benefits. "As you look around the world," West says, "the U.S. still looks pretty good." And that's likely to hold true for some time to come, whether it's the Republicans or the Democrats who prevail in November.
ASK YOUR ADVISOR
Ask your Financial Advisor what investment decisions to consider ahead of this year's presidential election.
ASK YOUR ADVISOR
Ask your Financial Advisor what investment decisions to consider ahead of this year's presidential election.
- Which sectors might be best suited to weather the market volatility that may occur near the elections?
- If interest rates change, how could my bond portfolio be affected?
- Does my retirement plan account for a possible drop in Social Security benefits?
