With the election just a month away, many are worried about what lies ahead. And because of that, the most frequently asked question in recent weeks has been: Does it make sense to sell some stocks now, in advance of the election? My view: I see at least four reasons not to sell:
- Despite the polls, no one can be sure what the result will be.
- As we saw in 2016, no one can be sure how the market will react to that result.
- Even if the market does react negatively, that effect may be temporary.
- There is also the overlay of the pandemic, which makes an already unpredictable situation that much more difficult to assess.
To be clear, I fully acknowledge that the market could experience a downdraft over the next few months. So you do want to be prepared. I just don’t think selling stocks is the best way to prepare. Instead, I would prepare by examining your finances the way bond analysts evaluate bonds: They consider an issuer’s leverage, its liquidity and its cash flow. I think that’s a great framework for evaluating one’s own personal finances. In the end, after reviewing these questions, you might decide that it does make sense to sell some stocks, but I would only do that for a logical reason and not simply in response to the election.
Below are topics and questions to consider in each of those three categories:
Leverage (i.e., debt)
- With interest rates at historic lows, have you conducted an inventory of your loans? Most people focus on their mortgages—which makes sense—but don’t forget about student loans, business loans and even car loans, all of which can be refinanced.
- Do you have any variable rate debt? I have seen more than one person refinance an old variable-rate mortgage into a new fixed-rate mortgage at a lower rate.
- Are there any debts that you could extinguish with cash on hand? The question of whether to pay off debt, even when it carries a low interest rate, is one that gets a lot of airtime in the personal finance world. I would encourage you to look beyond the math and consider this question from all angles. From the perspective of risk management, I think it’s advantageous to reduce overhead expenses whenever possible. Even if your loans are affordable today, reducing leverage can provide an invaluable margin for error in case of a rainy day.
- Have you considered putting a line of credit in place, also to protect against a rainy day?
- As I noted earlier, I don’t worry about the stock market over the long term, but I acknowledge that anything can happen in the short term. If you were to experience an interruption to your income—or if you’re retired and regularly withdraw from your portfolio—do you have sufficient assets outside of stocks to carry you through a market downturn? This is where a sense of market history can be helpful: In just the past ten years, the S&P 500 has dropped by more than 10% on eight different occasions. In two of those cases, it was closer to 20%, and this year, of course, it was more than 30%. Over that same period, the market has nearly tripled in value, which is great, but the long term is irrelevant if you have a problem in the short term. That’s why liquidity may be the most important of these three considerations.
- Do you know the dynamics of your household cash flow? Do you have a sense of the breakdown between fixed and discretionary expenses, and how much you allocate to debt payments?
- Another key element of cash flow is your annual income tax burden. As recent years have proven, tax rules are not written in stone. If the president and Congress are aligned, a lot can change—and quickly. That’s why I recommend diversifying your assets in a way that allows you to hedge your bets tax-wise. This means having at least some assets in each of the three major categories: taxable, tax-deferred and tax-exempt (i.e., Roth, 529 or HSA). This is true regardless of who is elected in November, but it’s especially true at this time. That’s because this year the federal government will incur its largest deficit ever: more than $3 trillion, more than triple what it was last year. So it’s not hard to imagine tax rates going up in the future. While some economists believe we can simply print money indefinitely, I’m not so sure. And I wouldn’t be comfortable staking my financial security on a theory that is new and untested. What can you do? Again, everyone is different, but if you aren’t in your peak earning years, one strategy would be to complete some Roth conversions in 2020 at today’s historically low rates.
- If your assets are significant, you should also give thought to estate taxes. The current estate tax rules are set to expire at the end of 2025, but if there’s a political shift in January, that timeline could easily accelerate. What to do? Call your estate planning attorney today. Be prepared to wait on hold, but then ask what steps you could implement before the end of the year.