election years and the stock marketWith the 2012 presidential election just around the corner, there’s no doubt election years and the stock market are a focus for investors. When it comes to the stock market, you may even see headlines noting that Presidential election year returns are often abnormally high. For example, this article from US News may lead you to believe that election years and the stock market are as good as two peas in a pod.

But do election years and the stock market warrant such interest? Lets take a look at the research to find out if stock markets really outperform in election years. Across all Presidential elections since 1928 the average return on the S&P 500 is 11.02%.1 Sounds like a strong number until you consider the average return over the entire time frame of 1928 to 2011 was actually slightly higher at 11.46%!2

So how did myths around election years and the stock market begin? From 1928-2000, only two Presi­dential election years saw negative returns, meaning that about 90% of the years saw positive returns, averaging nearly 15%!2

Secondly the second half of the four year Presidential cycle tends to see strong returns, not necessarily just the last year. On average the first two years see gains of 8.54%, while the last two years average 14.39%.2

Election years and the stock market

Looking at the data we must conclude that savvy investors should only stay invested during the third and fourth years of the cycle and remain on the sidelines the rest of the time, right? Wrong. It’s easy to find patterns in large amounts of statistical data. Yet patterns are only helpful if they can be relied upon to continue.

Investors who believed in the election cycle theory would have been extremely disappointed with several of the recent election year results — a loss of 37% in 2008 and 9% in 2000. What had previously looked like a surefire bet is now indistinguishable from the long-term average for election years and the stock market.

Risk and return are related; nobody is able to predict market returns in advance. Yet some investing maxims stick around past their prime. Capitalism and the capital markets have proven to be strong wealth creators in the long term, stronger than any coincidences related to a small sample set of political election results. Investors with a long time horizon should not try to out­ think the market, but instead enjoy stock market gains whenever they occur.

Election years and the stock market both provide individuals with a wealth  of topical conversation. Just don’t bet your retirement on it.

1United States Elections Project
2Data Source: DFA Returns 2.0

About Katherine: Katherine Fonville is an independent Financial Advisor in Richmond, Va helping individuals and families with investment management, retirement planning, college planning, and financial planning goals.

Article is reprinted with permission from Loring Ward and Matthew Carvalho.