We all know the economy can affect presidential elections.
But how do presidential elections affect the economy?
Anytime our nation faces uncertainty, there will be a level of instability in the market. While that's temporary, it can make some investors nervous. During the weeks leading up to the election, we can probably expect to see some volatility related to comments the candidates make and policies they debate. This election is tight with polls regularly showing slight changes in sentiment, so the outcome is still very uncertain.
Don't worry, though, as temporary market fluctuations don't generally have a long-term economic impact.
After the election, we could see some short-term market behaviors based on which candidate wins. In general, there's less volatility associated with an incumbent winning a presidential election because that candidate is a known quantity. The challenger likely articulated his other economic policies, but we've still never seen the challenger as president.
As the Republican Party has generally been perceived to be friendlier toward large corporations and wealthy investors, Wall Street tends to prefer Republican candidates. Consequently, sometimes there is a small rally associated with a Republican victory.
World markets don't always react the same as U.S. markets. Internationally, Democratic leadership can signal the U.S. will have closer diplomatic ties around the world, which could lead to positive changes in world markets. But the Republicans' business-friendly reputation can extend to international markets. Any candidate who has expressed plans to increase excise taxes on imported goods may cause a little international volatility.
Presidential elections are, of course, accompanied by Congressional elections. The same tendencies generally apply to these election results. Markets may see less volatility if power is split—in other words one party controlling the executive branch of government while another controls the legislative branch, which tends to temper policy changes.
The Election and Your 401(k) Plan
You should prepare for short-term volatility in your 401(k) investments during the run-up to the election by having a plan you feel comfortable sticking with. Making changes based on short-term reactions in the market historically doesn't produce long-term results. Expect the unexpected, but set a path toward reaching your personal goals. You can prepare yourself against making emotional transactions in your retirement plans by understanding what each candidate could bring to the markets'.
If President Barack Obama is re-elected, look for some additional volatility soon after the election in response to moves he makes—or is, theoretically, able to make—quickly. Second-term presidents are unworried about re-election. Regardless of their political party, they've often been bolder and able to accomplish more.
If challenger Mitt Romney is elected, look for volatility as he's sworn in next year. New presidents often try to hit the ground running with legislative changes as they attempt to use the momentum they gained from victory.
Longer-term, the outcome of the election could certainly impact your investments. Every presidential election has had that power. But right now it's impossible to know how it will change the economic outlook.
I don't plan to alter my allocation based on which candidate is elected, but I will pay attention to policy specifics related to economic changes when they're actually going through the legislative process. Bottom line, create a plan for yourself and don't react emotionally to market volatility—regardless of the political rhetoric.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.