Why It's Risky to Mix Politics and Investing

As you might have heard, today is Election Day. And it's for the big prize, too: president of the United States. We won't have another day like this until 2012. By then the government will own all the banks and we'll get to elect all their CEOs.

Amid all the excitement, it might be tempting to try to make money off the election. And this time around, as in every election season, a number of commentators have offered advice on how to do just that. Invest in this stock, or that fund, or this or that commodity, because it's likely to rally if Candidate X or Y enters the White House.

Should you act on that advice? It's tempting to do so--especially if you're reading this in the days after it first appeared on Morningstar.com and already know who won. Why not buy the stocks and funds that will benefit from the new regime's priorities?

Well, there are several reasons why caution is warranted. Think twice before buying with politics in mind.

Not a Clear-Cut Path to Gains
First of all, remember the nature of the presidency. Most obviously, although media outlets focus enormous attention on the president alone, this concentration overstates one individual's influence. Even if a candidate holds a specific position dear and pledges to push through legislation to further that goal, the story doesn't end there. Congress has to pass the legislation, and that can be a struggle.

Moreover, it isn't certain that an issue will even reach that stage. After all, on the seemingly endless campaign trail, candidates make many different statements to many different audiences. It's tough to know which positions the candidates truly feel most strongly about, or which ones they'll feel have the best chance of passage. Even if they're sincere about all their statements, there's no way that a candidate can put maximum effort into translating each position into action once in office. Some will fall by the wayside. After all, a few positions were never held too strongly in the first place. Others will run into budget constraints. Some might be pushed but get nowhere.

It's a Complex World Out There
Even if we knew what changes will go into effect, the effects on specific types of investments isn't as obvious as it might seem. Many factors outside the control of the president, or of Congress, affect the fortunes of individual companies and entire sectors. An internal financial scandal, failed product launch, or unwise acquisition can sink a company's stock price regardless of whether a piece of legislation supposedly helpful to that company's industry has passed into law.

The uncertainty extends beyond individual stocks. Entire sectors can find themselves at the mercy of commodities prices, currency swings, and the always-unpredictable whims of consumers. Unexpected foreign shocks--military, political, or financial--can hit the whole market hard. Certainly some presidential decisions, especially those that don't require congressional approval, can have an influence on the U.S. economy or the stock and bond markets. But that influence is limited. Global economic conditions, meanwhile, are beyond the president's control. In fact, as we've seen recently, they're beyond anyone's control.

Two Examples Show the Dangers
The past offers examples of how tenuous the connection between a candidate's ostensible positions and subsequent investment results can be. In 1992, a feeling arose that should Bill Clinton win the White House, environmental stocks would benefit--mainly because Al Gore, even then known for his pro-environment views, would become vice president. Clinton and Gore did win, and a slew of "environmental" mutual funds came out.

Bad idea. As it turned out, sweeping pro-environment legislation wasn't the first thing pushed by the new administration. Or the second or third. Some environment-related actions eventually did emerge, but it still wasn't clear exactly what impact they would have on various companies. Most critical, though, was the vagueness of the investment concept. After all, what should an "environmental" fund actually invest in? Not an easy question to answer in the early 1990s. The funds made up their own solutions, and they ended up owning "green" firms that focused on alternative energy along with cleanup companies such as Waste Management plus a hodgepodge of various other stocks added in to fill out the portfolio. Not surprisingly, the funds proved disappointing, and most were merged away or liquidated.

A more recent example shows the perils of taking such plays overseas, even when the bet seems obvious. The 2007 presidential election in France pitted a Socialist candidate, with positions that many in the financial world feared could be detrimental to economic growth, against a candidate considered much more business-friendly. The business-friendly candidate, Nicholas Sarkozy, won. He took office in mid-May. Time to invest?

As it turned out, no. From June 1, 2007, through the end of January 2008, iShares MSCI France Index (EWQ) suffered a loss of roughly 12%. It lagged  iShares MSCI Germany Index (EWG) by a whopping 8 percentage points. Even if you take May 1 as the start date--meaning an investor got in nearly a week before the election--the France fund suffered a double-digit loss and lagged its Germany counterpart by 10 percentage points. Since then, iShares MSCI France has outperformed the Germany fund by a small margin. More critically, though, its shareholders have suffered staggering losses--more than 40%--for the 12 months through October 2008. Even a pro-business president couldn't do much about a global financial meltdown. 

It's possible a "Sarkozy play" will prove to have been a wise bet over the long run. But the short-term result provides an example of how an apparently logical political play can easily backfire.

Failure isn't guaranteed, of course. There's no ironclad reason why purchases with political reasoning behind them couldn't work out well in some cases. But is it really worth taking the plunge in such murky waters? It seems more beneficial, and frankly less difficult, to instead simply choose topnotch funds with reasonable costs run by excellent managers or to simply go with appropriate index-fund choices--and leave your political decisions at the dinner table and the voting booth.

A version of this column ran Feb. 5, 2008.