Post-Election Investment Strategies

The global economy has experienced a number of significant events in 2012 that have influenced the markets.

Recurring headlines have focused on a slowdown in the Chinese economy as well as the ongoing Euro zone crisis. In the United States, our sluggish growth and slowly improving unemployment and housing market are constantly at the forefront of media coverage. More recent discussions have turned to focus on the impact of the recent U.S. election. As we make preparations to close the year and look forward to the next, we encourage investors to carefully review their portfolios and consider the following year-end strategies with their team of trusted advisors.

2012 Election Results

In the months leading up to the election, the U.S. endured grueling campaigns with over $6 billion spent by the candidates and affiliated parties. Once the votes were counted, however, the spending and campaign efforts yielded little change in Washington. President Obama has been re-elected and Congress will see no changes in leadership since the Democrats and Republicans maintained control of the Senate and House, respectively. With the election uncertainty behind us, attention has once again turned to the looming “fiscal cliff.” Without compromise in Washington, huge tax hikes and spending cuts are due to take effect at the end of the year. With a divided government and a continuation of gridlock, the markets are likely to remain volatile and the U.S. economy may feel profound effects.

The first and most pronounced issue is the potential sunset of the Bush-era tax cuts that are set to expire at the end of the year. Under current law, qualified dividends and long-term capital gains are taxed at a maximum rate of 15%. President Obama has expressed a desire to keep these preferential tax rates in place for any married couples with income less than $250,000 annually and for any singles with income less than $200,000 annually. Those with income over these thresholds can expect to see the long-term capital gains tax rate increase to 20% and the dividend tax rate increase to 39.6% next year. There is still a great deal of speculation that there is room for these income levels to be higher (or lower), but what does seem to be evident is that “high-income” earners will likely be paying more in taxes. This type of policy change might lead to a temporary decline in equity markets as investors take profits and lock in lower tax rates on gains realized from stocks that have seen a considerable run-up over the last couple of years. We might also see increased interest in municipal bonds as more affluent investors shift portfolio allocations to avoid the adverse impact that higher tax rates may have on their after-tax yields and the performance of their portfolios. 

Furthermore, 2013 will also see the introduction of a 3.8% Medicare contribution tax. This tax will apply to the lesser of a taxpayer’s net investment income or their gross annual income in excess of the threshold amounts. The threshold amounts are $250,000 for married couples, $125,000 for married individuals filing separately, and $200,000 for singles. You should consult your advisor on what constitutes investment income and possible strategies to consider.

In addition, Obama’s re-election likely means continued support for the Federal Reserve and its aggressive quantitative easing measures. With more money being injected into the economy, future inflation remains a meaningful concern for investors. Accordingly, it is likely that we will continue to see investor appeal for inflation-linked bonds, commodities and gold, all of which tend to perform well in an inflationary environment. 

Finally, investors should be discussing with their advisors what sector opportunities and risks might exist as we enter the second term of the Obama administration and how to position portfolio investments appropriately. For example, good discussion topics might include the administration’s stricter environmental and financial regulations on the energy and financial sectors. Proactive portfolio management and review is always a good idea, even while we wait out the “lame duck” period.

Year-End Steps for Investors

During this time of uncertainty and market volatility, it is critically important for investors to stay focused on their investment goals and objectives. First, investors should review and rebalance their investment allocations as necessary. Rebalancing a portfolio ensures that investors’ targets for each asset class remain intact and that the portfolio can weather volatile market conditions. According to empirical research, a strategic asset allocation contributes to 90% of a portfolio’s variability over time.  Thus, it is in investors’ best interest to rebalance their portfolios periodically, especially during periods of heightened uncertainty. Additionally, as the markets are likely to remain volatile, it may be a good time to make sure your portfolio is positioned appropriately to ensure the portfolio is not taking more risk than is appropriate.

Following a review of the overall portfolio, investors should carefully review the investment managers in their portfolios. Since the markets have dropped significantly in the days following the re-election of President Obama and are likely to remain challenged until a resolution of the fiscal cliff issues, it is important for investors to ensure their investment managers remain suitable for their portfolio. Key areas to assess are historical performance in both up and down markets, manager strategy, and total costs including the direct management fee as well as any custody and trading fees incurred. 

Many investors have become well-versed on popular year-end tax planning techniques, which generally involve a review of any gains or losses recognized to date and whether any action should be taken to minimize the tax bite on those gains.  However, with the anticipation of tax-rate increases, investors may find it more prudent to discuss accelerating capital gains to take advantage of the lower tax rates. The sneaky wash sale rules, which can disallow losses on positions that a taxpayer re-enters within a short period of time, do not apply to realized gains. Therefore, investors can lock in the benefit of lower 2012 tax rates and reduce the overall tax exposure on the portfolio assets without any real impact to the underlying investments.  The current tax rates also make this a particularly opportune time to consider diversifying out of concentrated and/or highly appreciated holdings, easing the tax burden and better positioning the portfolio to weather volatility. For investors who have long-term capital loss carryovers, however, these strategies might not be as effective, since the loss may be better used against the higher tax rates looming on the horizon. In any event, we encourage investors to work with competent tax and investment advisors who can collaboratively analyze, plan, and implement appropriate strategies both at year-end and throughout the year.