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What an Election Year Means for Your Investments

Election years bring uncertainty, and this year’s presidential election is no exception. However, you might be surprised to learn that history shows they usually don’t have much impact on your portfolio. In this post, we’ll dig into the data.

What history tells us about investing during election years

To understand the impact of presidential election years on investments, we looked at US stock market data all the way back to 1927, using Kenneth French’s data library. First, we analyzed mean annual returns for the US stock market for all years 1927-2023 compared to election years during that period of time. 

We found that the mean annual total return for non-election years was 12.1% and the mean annual total return for election years was 11.7%. The chart below shows these returns. However, we also performed a t-test (a way of discerning whether or not results are statistically significant) and found that the difference between election year and non-election year returns was not statistically significant. In other words, US stock market total returns are pretty much the same on average whether or not it’s an election year.

 

Next, we compared average annual volatility in the US stock market in all years from 1927-2023 to see if election years are meaningfully more volatile than non-election years. We found that mean volatility in non-election years was 15% over that time period, and mean volatility in election years was 15.3%. However, once again, our t-test confirmed these differences were not statistically significant, meaning the US stock market, historically, is just about as volatile on average in an election year as it is in a non-election year. 

Finally, we compared the average maximum drawdown (or largest decline from a recent peak) in the US stock market in all years from 1927-2023. We found that the average maximum drawdown was slightly greater in non-election years at -16.0% than in election years at -14.6%. Again, however, these differences were not statistically significant. 

It’s worth noting that our analysis picked up some small differences between election years where Republican candidates won and Democratic candidates won. The US stock market had slightly higher mean returns, lower mean volatility, and smaller maximum drawdowns during years when a Republican won the presidential election. Here again, our hypothesis testing did not find evidence that any of these differences were statistically significant. Especially given the small number of total data points, the historical differences observed are small enough to be attributed to random chance. 

Even if the market does decline or become more volatile in the short term (which is always possible), it’s important to keep an eye on the long term. Risk of loss generally goes down as your investing time horizon gets longer. If you plan to be in the market for the long run, fluctuations in your account balance today could end up being blips on the radar in the future.

Should you adjust your investment strategy in an election year?

Put simply, we don’t think so. As tempting as it may be, timing the market usually doesn’t work. Any information you have that you think might impact investment performance is presumably already broadly available. This means it’s already priced in, and you’re unlikely to come out ahead. 

Instead, we suggest focusing on what you can control:

  • Managing your risk: Invest in a portfolio that is appropriate for your risk tolerance, and rebalance it over time to ensure you don’t drift too far from your target allocation. Itrust automates this process so you don’t have to think about it. 
  • Keeping your costs low: Choose low-cost index funds whenever possible, and invest with a service that charges a low management fee (Itrust’s annual fee is just 0.15%). 
  • Minimizing your taxes: Harvest losses and use them to help lower your tax bill. The process of tax-loss harvesting can be time consuming if done manually, but Itrust does this automatically and at no extra cost. 

Major events like elections can rattle investors. And while it’s true that there are some small differences in the annual returns, volatility, and maximum drawdowns observed in years when the United States elected a new president, it’s worth remembering that the number of data points is very small and the differences were not statistically significant. If you look at the big picture, these small differences in performance are ultimately not worth paying much attention to. 

Ask: Should I Pay Off My Mortgage Early or Invest?

Welcome to our Ask series, where we tackle your questions about personal finance and investing. Want to see your question answered here? Reach out to us on social media and we’ll try to address it in a future column. 

If I have extra cash, should I use it to pay off my mortgage early or invest?

If you have cash to spare and are currently paying a mortgage on your home, you might wonder if you should use that extra cash to pay off your mortgage early (also known as prepaying your mortgage) or use it to add to your investments, like an Automated Investing Account at Itrust, instead. There’s no one-size-fits-all answer, but in this post, we’ll provide a framework for thinking about the decision. 

At Itrust, we believe investing is key to building long-term wealth, but there can also be benefits to paying off your mortgage sooner. For the purposes of this post, we’ll assume you have a 30-year fixed-rate mortgage. Here are some factors to consider as you decide between paying off your mortgage early and investing.

Make sure you really have extra cash

Cash plays an important role in our financial lives. It’s true that having too much cash can work against your long-term financial health, but it’s important not to overcorrect: Having insufficient cash can be very stressful. Before you decide to pay off your mortgage early or invest, it pays to make sure you really have extra cash. As a rule of thumb, we think it makes sense to hold enough cash to cover the following:

  • A good emergency fund, with three to six months’ worth of expenses
  • Any significant known expenses within the next year. This could include things like an upcoming vacation, your wedding, or a large home repair. (An exception: You could also consider keeping money for large near-term expenses in an investment account with very little risk to your principal, like Itrust’s Automated Bond Ladder.)
  • Your regular monthly expenses that you cover out of each paycheck, like groceries and childcare

If you don’t have enough cash to cover these items without dipping into your savings, consider holding off on either putting more cash in the market or paying off your mortgage early. 

Pay off your highest interest debt first

Once you’ve confirmed you do have extra cash, you should take stock of all of your debt—not just your mortgage. Some debt is far more expensive than other debt. You can tell how expensive your debt is by looking at the interest rate you’re paying on it: Debt with a higher interest rate is more expensive to you. Because of this, it usually makes sense to pay off your highest interest debt first.

Let’s imagine you have $10,000 in credit card debt and the APR (annual percentage rate) on that debt is 24.62% consistent with the national average as of June 5, 2024. Let’s also imagine you have a 30-year fixed-rate mortgage with an interest rate of 7.40%, consistent with the national average as of June 21, 2024. If you received a $10,000 bonus at work, it would make sense to pay off your credit card debt first because that debt has a significantly higher interest rate than your mortgage, and it’s probably much higher than your expected returns from investing, too.

Take a closer look at your mortgage interest rate

If you’ve already handled your high-interest debt, then it makes sense to compare the interest rate on your mortgage to your expected returns from investing. Your expected returns can be difficult to predict, but you can use tools like Itrust’s historical performance page to make a more informed guess. When you pay off debt with a known interest rate, you’re essentially getting a known rate of return on your money because you know exactly how much you’ll save in interest. Let’s say the interest rate on your mortgage is 2% (lucky you!) and your long-term expected return from investing is 5%. You could make the case for investing your extra cash, because your interest savings from paying off your loan are likely to be lower than your investment returns, even after taxes. Keep in mind, however, that “expected returns” are just that—expected, not guaranteed.

On the other hand, if your mortgage interest rate is 7% and your expected return from investing is still 5%, you might want to take the opposite approach and pre-pay your mortgage. That’s because the amount you would save in interest is higher than what you’d expect to earn on that money if you invested it. 

But what about the mortgage interest tax deduction? If you itemize your tax deductions, you can deduct the interest paid on up to $750,000 of mortgage debt for homes purchased after December 16, 2017 on your tax return. This means if you prepay your mortgage, you could lose some or all of this deduction. In general, we don’t think this should be the driving force behind your decision, but it is important to be aware of the tax implications of mortgage prepayment. Here’s a very simplified example to help you think this through: If you have a mortgage interest rate of 7%, you qualify to deduct your interest, and your tax rate is 30%, then the after-tax rate on your mortgage would be 4.9% (or 7% x (1 – 30%)). Just remember that in order to get an apples-to-apples comparison, you’ll want to compare this after-tax interest rate to your expected after-tax investment return, which can be even more difficult to accurately predict than pre-tax returns.

Prepayment, recasting, or refinancing? Consider your options

Paying off debt like a mortgage early can be psychologically rewarding, but prepayment isn’t your only option. Some people incorrectly assume that prepaying their mortgage will automatically lower their monthly payments going forward, but this generally isn’t the case. However, there are alternatives to prepayment that do have the potential to lower your monthly payments. Here’s a quick overview of various options and how they compare:

  • Mortgage prepayment: Paying extra money towards the principal (or loan amount) of your mortgage. Prepayment allows you to pay off your mortgage faster and save money on interest, but doesn’t change the amount of your monthly payments. Occasionally, you may pay a prepayment penalty for paying your mortgage off early (more on that below). 
  • Mortgage recasting: Paying extra money towards the principal of your mortgage, and then recalculating your monthly payments. Recasting lowers your monthly payments and saves you money on interest, but you won’t pay off your mortgage any earlier. You may also need to pay a fee of a few hundred dollars to recast.
  • Mortgage refinancing: Taking out a new mortgage, usually at a lower interest rate, with the goal of lowering your monthly payments and the total amount you’ll pay in interest. Refinancing can change the date you’ll pay off your mortgage in either direction, depending on the terms of the new loan. Refinancing can come with significant fees—potentially two to five percent of the new loan amount.

Consider your amortization schedule

Most of the time (assuming you have relatively standard loan terms, and not a less common arrangement like an interest-only mortgage or a balloon mortgage), your mortgage payment includes a mix of principal and interest—and over time, that mix changes. Mortgage payments are mostly interest when you first take one out, and they gradually include more principal as more time goes by and you build more equity in your home.

If your mortgage payments still include a lot of interest, there’s likely more benefit to prepaying, recasting, or refinancing. On the other hand, if you’re paying mostly principal, there’s less benefit to prepaying, recasting, or refinancing and you are more likely to be better off investing your extra cash instead.

Check your mortgage’s prepayment terms

Prepayment penalties, or fees for paying off your mortgage early, aren’t very common. But if you’re considering prepaying your mortgage, you should make sure that your lender won’t penalize you for it.

Why would lenders do this? When you prepay your loan principal, you are ultimately reducing the amount of interest you’ll pay your lender. Prepayment penalties are a way for lenders to recoup some of that lost interest, and these penalties vary in both amount and structure—you could owe a flat fee or a percentage of the loan balance, for example. Read the details of your mortgage carefully and don’t be afraid to ask your lender to clarify if you’re unsure about your prepayment terms. If your mortgage does include a prepayment penalty, make sure you are cognizant of this cost—it could tip the scales towards investing instead.

Key takeaways

To recap, here’s what we suggest keeping in mind as you consider the tradeoffs involved in prepaying your mortgage or investing.

  • Before you pay off your mortgage early or invest, make sure you actually have enough cash on hand.
  • Take stock of all of your debt and consider paying off your highest interest debt first.
  • Compare the interest rate on your mortgage to your expected return from investing.
  • Prepayment isn’t your only option. Look into recasting and refinancing if your goal is to lower your monthly payments. 
  • You’re more likely to benefit from mortgage prepayment if you took out your mortgage relatively recently and your payments still contain a lot of interest.
  • Don’t forget to check your mortgage’s prepayment terms.

If you ultimately decide it makes sense to invest your savings instead of prepaying your mortgage, we suggest investing in a globally diversified portfolio of low-cost index funds like Itrust’s Classic portfolio. We’ll help you maximize your risk-adjusted returns and minimize your taxes while our software handles all of the busy work like trading and rebalancing for you. 

We hope this helps!

How Can I Minimize Taxes When I Invest?

Taxes often signal good news for investors: they’re usually a sign you’re making money. At the same time, taxes can also eat into your returns and reduce the amount of earnings that you get to keep. Fortunately, there’s a lot you can do as an investor to lower your tax bill and invest more tax-efficiently. In this post, we’ll explain seven ways you can minimize the taxes you’ll owe on your investments.

1. Invest in index-based ETFs

Index-based ETFs are exchange-traded funds that let you track a broad market index with one investment.  They are inherently tax-efficient because they pass on very few earnings (or “taxable gains”) to investors who own the ETF, even when the value of the ETF is increasing—which, of course, you hope it will over the long run. 

How do index-based ETFs manage this? One, there’s not much change in the companies included in an index from year to year—typically, there’s only about 5-20% turnover each year, depending on the index in question. As a result, the ETF manager doesn’t have to sell stock that’s at a gain very often in order to remove it from the ETF’s holdings. And two, ETF issuers can reduce the gains they have to pass along to investors by intelligently realizing investment losses on the individual investments that make up the index.

2. Invest for the long term

Long-term investing isn’t just a smart way to take advantage of compounding—it’s also more tax-efficient than short-term investing. That’s because your investments are taxed at a much lower rate if you hold them for at least a year and a day, meaning you get to keep more of what you earn. To get this lower tax rate, you need to hold your investments long enough so that your gains will be treated as long-term capital gains, not short-term capital gains. 

Long-term capital gains are taxed at a maximum rate of 20% at the federal level. By contrast, short-term capital gains are taxed at the same rates as ordinary income (like your paycheck). The top tax rate at the federal level for short-term capital gains is 37% in 2022. 

3. Optimize your asset allocation for taxable and tax-advantaged accounts

You should factor in the rate at which your investments will be taxed when you select an asset allocation. The fancy name for this is “asset location,” but it really just means choosing the right investment mix for each type of account you have. For example, if you have a Roth IRA, any withdrawals after age 59 ½  that follow IRS rules should be tax-free. Because of this, you might consider holding more investments with less favorable tax treatment in that account than you would in a taxable account. 

Asset location can be complicated to figure out on your own, which is why you might prefer to let a service like Itrust do it for you. Itrust uses what’s known as “differentiated asset location” in choosing the right mix for your taxable and tax-advantaged accounts. Our software evaluates the way each asset class is taxed, its risk and return profile, and how it balances out other asset classes to pick the mix that’s right for your account and situation.

4. Rebalance with dividends

Rebalancing your portfolio means buying and selling investments to keep your mix of investments (or “asset allocation”) from drifting too far away from what you want it to be. In other words, you sell some of the investments that have done well and you buy more of the investments that have performed less well. Rebalancing is important because it ensures your portfolio stays at (or near) your intended level of risk and expected return.

Let’s say you had a portfolio with 60% stocks and 40% bonds, and stocks performed extremely well and bonds did not. Over time, your asset allocation might drift to 70% stocks and 30% bonds. To rebalance your portfolio and get back to your target allocation, you would need to sell some stocks and buy some bonds. 

Of course, selling your winners usually means realizing some taxable gains. Fortunately, dividends can help with this. If you hold investments that pay dividends (for investments offered at Itrust, this information is readily available if you search here), you can use those dividends to rebalance your portfolio by buying investments you need more of. This should reduce the number of investments you need to sell to rebalance your portfolio, and reduce your tax bill as a result. When you invest with Itrust, we automatically rebalance your portfolio with dividends. 

5. Harvest your losses

Tax-loss harvesting is a strategy that has historically been used by sophisticated, wealthy  investors with high-end financial advisors to lower their tax bills. The concept is simple: when an investment declines in value below its purchase price, you sell it, “harvest” the loss, and then buy a similar investment that keeps your portfolio at the right level of risk and expected return. Come tax time, you can use the losses you’ve harvested to effectively cancel out other capital gains so you don’t owe taxes on them. No gains? No problem. You can use your harvested losses to offset up to $3,000 of ordinary income (like your salary) each year and carry the rest of the losses forward to a future year.

As you might imagine, tax-loss harvesting can become very time-consuming if you’re doing it manually. Itrust’s Tax-Loss Harvesting service automates this process with the ETFs in your portfolio at no extra cost, and because software doesn’t get bored, it can look for losses every day the market is open and find more opportunities to harvest them than a human checking a few times a year is likely to. In 2021, our Tax-Loss Harvesting service generated average estimated tax savings worth between 4-9x our annual 0.25% advisory fee for clients who started using the service in a Classic or Socially Responsible portfolio last year.

Direct indexing

If you’re really serious about maximizing your harvested losses, you can use a strategy known as direct indexing. Direct indexing involves holding the individual stocks that make up a given index (rather than an ETF that tracks the index) and conducting tax-loss harvesting with those individual stocks. Individual stocks tend to be more volatile than indexes, so it’s easy to imagine a situation where a broad index might be up but a few individual stocks are down. As a result, you’ll generally get more opportunities to harvest losses with direct indexing than you would with ETF-level tax-loss harvesting. At Itrust, we offer our Direct Indexing service in all taxable Investment Accounts of at least $100,000 at no extra cost. 

6. Incorporate your existing investments when you transfer between accounts

Selling investments that have increased in value generates a taxable gain—and that means you’ll probably owe the IRS money. So if you’re moving investments from one platform or institution to another, you can minimize your taxes by incorporating existing investments into your new portfolio whenever possible (instead of selling and realizing a gain, moving your money, then buying the same investments all over again). At Itrust, our software automatically incorporates your existing investments whenever it can.

7. Keep taxes in mind when you make withdrawals

If you make a withdrawal from your investment account, you will typically need to sell some investments. To minimize the taxes you’ll owe, don’t just sell investments at random. Instead, consider selling investments that have lost value first—this won’t generate any taxes—followed by investments with relatively small gains, or gains that qualify for long-term capital gains treatment. This can help you minimize the taxes you’ll owe as a result of the withdrawal. When you withdraw from an Investment Account at Itrust, our software automatically sells investments to keep you close to your desired asset allocation—and within each asset class, we sell investments tax-efficiently. 

Bonus tip: use a robo-advisor to improve your after-tax returns

If you have a lot of time on your hands, it’s possible to implement most of the tips in this article by yourself. But it probably won’t be fun. When you invest with Itrust, we automate all of this for you to help maximize your after-tax returns with no extra effort or extra cost on your part. The following services are all included in Itrust 0.25% annual advisory fee:

  • Expert-built portfolios of index-based ETFs 
  • Different asset allocations for taxable and tax-advantaged accounts
  • Tax-sensitive rebalancing with dividends 
  • Tax-loss harvesting
  • Direct indexing (for accounts of $100,000 or more) 
  • Tax-minimized brokerage transfers
  • Tax-minimized withdrawals 

At Itrust, we’re focused on maximizing your after-tax returns: we believe that’s a big part of what sets us apart from other robo-advisors. At the end of the day, we want to see our clients (you!) successfully build secure and rewarding financial futures. Helping you keep more of what you earn is just one way we try to get you there a little faster.

Ask : Should I Invest My Down Payment?

Welcome to our Ask series, where we tackle your questions about personal finance and investing. Want to see your question answered here? Reach out to us on social media and we’ll try to address it in a future column. 

I’m saving for a house. Should I invest my down payment or keep it in cash?

As you decide whether to invest your down payment or keep it in cash, you’re primarily making a decision about risk. Investing, by definition, involves some risk—but that’s why it can offer higher expected returns over the long run. Cash is very low risk, but it is likely to offer lower expected returns.

In this post, we’ll give you a framework for thinking about risk in the context of your down payment so you can decide what’s right for you. We’ll highlight the tradeoffs related to three options you might consider: 

  1. Keeping your down payment in cash
  2. Investing your down payment in a low-risk investment like US Treasuries
  3. Investing your down payment in a diversified portfolio

The argument for keeping your down payment in cash

Keeping your down payment in cash is a great option if you expect to buy a home imminently or if you are unwilling or unable to take any risk to your principal. If you keep your down payment in a savings account or high-yield cash account, you’ll have a high degree of certainty that your money will be there when you need it. However, you’ll be making a tradeoff when it comes to expected returns.

Over long periods of time, cash is unlikely to earn enough interest to keep up with inflation. So if you keep your down payment in cash for long enough, you could actually lose buying power. If you plan to buy a house imminently, this is unlikely to be an issue. But over longer periods of time, you could be leaving potential returns (and thus housing budget) on the table.

If you do decide to keep your down payment in cash, we suggest picking an account with a very competitive APY and adequate FDIC insurance. Many banks pay next-to nothing in interest and, as insured depository institutions, are limited to $250,000 in FDIC insurance per account holder. But the Itrust Cash Account offers an industry-leading 4.50% APY and up to $8 million in FDIC insurance ($16 million for joint accounts) through our partner banks. Plus, the Cash Account comes with no account fees and your money is readily available when you need it. By choosing a good home for your cash, you can ensure your down payment earns a competitive interest rate and is well protected in case of an unforeseen event.

The argument for investing your down payment in a low-risk investment like US Treasuries

While holding cash can feel psychologically rewarding, it could make more sense to invest your down payment in a low-risk investment like US Treasuries. While they have a lower expected long-term return than a diversified portfolio of US equities, US Treasuries can offer a steady yield until maturity and the interest you earn is exempt from state and local income taxes. At the same time, US Treasuries are backed by the full faith and credit of the US government, which is why they are considered among the safest investments in the world. If held to maturity, US Treasuries pose virtually no risk to your principal, although you run the risk of losing some principal if you sell before then (if interest rates go up, the price of the bond may decrease). 

Because of these benefits, US Treasuries can be a very attractive and low-risk way to invest your down payment whether you’re buying a home in a few months or a few years. You could argue that US Treasuries are the sweet spot between holding your down payment in cash and investing it in a diversified portfolio. And if you want to minimize the risk associated with interest rate fluctuations, you could consider building a US Treasury ladder (a type of bond ladder) with US Treasuries of varying maturities. 

At Itrust, we built our Automated Bond Ladder (a ladder of US Treasuries) to make it easy to benefit from a bond ladder strategy without any of the hassle it normally entails for a low annual advisory fee of 0.25%. The Automated Bond Ladder can be a great way to invest your down payment if you want to keep your level of risk very low and take advantage of state income tax exemptions, and it comes with up to $500,000 of SIPC insurance. When you’re ready to buy a home, your ladder is very liquid and there are no early withdrawal penalties. You can even set a target withdrawal date for your Automated Bond Ladder, which can be useful if you have a timeline you’re fairly confident in.

The argument for investing your down payment in a diversified portfolio

Finally, if your time horizon for buying a home is five or more years away, you might consider keeping your down payment in a diversified portfolio of low-cost index funds. It’s true that this type of portfolio (like Itrust’s Classic portfolio) comes with more risk than cash or US Treasuries, but that risk could also get you higher expected returns over the long run. There’s also a well established relationship between risk and time horizon, and the longer you stay invested, the lower your probability of loss. 

As you get closer to actually buying a home, it could be wise to shift your down payment from a diversified portfolio to one of the lower-risk options discussed above. The reason for this? Financial markets are unpredictable in the short term and can be volatile. It would be unfortunate if the market declined steeply at the exact time you needed to liquidate your investments to purchase a home—you could end up with a smaller down payment than you’d hoped for, and you’d also be selling investments when they’re down (which is nice to avoid if you can).

Key takeaways: Should you invest your down payment?

There’s no one-size-fits-all answer to whether or not you should invest your down payment, but there are some rules of thumb to keep in mind:

  • If you plan to buy a house imminently, it probably makes sense to keep your down payment in cash.
  • If you plan to buy a house soon (a few months to a few years from now) and want to earn a higher yield with very little risk, consider investing in US Treasuries.
  • If you’re at least five years away from buying a home and are willing to take on additional risk in order to potentially grow your down payment, a diversified portfolio of index funds could be a good fit.

It’s also an option to split your down payment if you believe you can benefit from a variety of approaches—you don’t have to keep all of it in one place. For instance, you could keep half of your down payment in cash and the other half in a diversified portfolio of low-cost index funds if you wanted to balance out a higher-risk option with the lowest risk option. 

We hope this helps!