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Charles A. Jaffe: How the candidates may affect investors

Now that the race for the White House has been narrowed to two major candidates, it's time to consider the election from the standpoint of a fund investor, trying to decide which candidate is better for the portfolio.

Now that the race for the White House has been narrowed to two major candidates, it's time to consider the election from the standpoint of a fund investor, trying to decide which candidate is better for the portfolio.

It's not that fund investors should vote with their wallets rather than their consciences, but rather that anyone undecided and not concerned about party lines might want to factor in how the election could hit home financially. It is also very early to analyze the situation, as neither candidate has come out with enough economic and tax-policy information to make everything clear.

Still, chatting with veteran political and fund-industry observers, there are some conclusions to be drawn.

The conclusion most people jump to is that the business and investment community should always favor Republicans, but that is not quite so clear at the presidential level. Historically speaking, the stock market has performed better with a Democrat in the White House than a Republican; on a short-term basis, analysts suggest that trend could continue.

"History has shown that the first two years of a presidential term tend to be the worst years for the stock market, but you could certainly expect that any policy that favors fiscal expansion would be better received by the stock market in the short term," says Thurman Smith, of Equity Fund Research in Malden, Mass. "You can argue about what is the best course for the economy in the long term, but if you expect Obama to increase government spending, then you would expect the market to do a little better for the first two years than if McCain wins."

Smith and others are quick to note, however, that the president has only a limited impact on the economy and even less effect on the market, so short-term market potential is not a particularly convincing reason to vote.

A bigger reason might be who can help you best grow your nest egg. Neither candidate has said much on any type of savings policy – and there is nothing on the legislative horizon that calls for immediate action – so that's worth watching, but is currently a push.

The big area of concern for fund investors, therefore, is on the tax front. Reduced tax rates on capital gains and dividends will expire in 2010, and Sen. John McCain is on record as saying he would like to keep current levels. That doesn't mean a tax hike is out of the question, but it might be some sort of compromise, where the rate on dividends and capital gains goes up, but not all the way to ordinary income levels. Moving from the current 15 percent rate to, say, 18 percent, is a far sight better than eliminating the difference and taxing those items as ordinary income, which typically means about 28 percent.

Sen. Barack Obama's policies here are not so clear. He apparently favors eliminating the special tax treatment for dividends and capital gains, but with an exclusion for people with lower incomes; whether that means the dividend rate will stay low for average fund investors depends on how those levels would be set.

While fund investors will be nervous over any change in rates, the impact of a hike is less far-reaching than expected. The industry controls about $11 trillion today, but most estimates suggest that a bit more than half of that money is in tax-deferred accounts, meaning that it will be unaffected by any proposed changes in taxing dividends and capital gains. Then there's roughly $3.5 trillion in money-market funds, where gains are taxed like interest income.

That means that only one-fifth of the assets in funds could be affected by the changes; even that number is a bit high, because of the billions invested in certain bond funds.

"If you're invested mostly in tax-deferred accounts, any change in the dividends and cap gains rate doesn't matter to you, because everything comes out as ordinary income tax," says industry consultant Geoff Bobroff of East Greenwich, R.I. "And while there could be changes to the ordinary income-tax rates, it won't be the president making that happen."

The bigger concern for all investors should be that whatever happens to dividends and capital gains is done equally, so that the investment incentives for money managers and investors are not suddenly changed. If tax policy were to suddenly and dramatically favor dividends over capital gains, money managers would invest with a bias toward the better tax situation. That would be bad for the market; luckily, neither side has said it wants to create that kind of imbalance . . . yet.

In the end, fund-specific issues probably aren't enough to push a voter to one side or the other, at least not on the basis of what the candidates have told us to date about projected policies. Investors with taxable accounts can give McCain the edge, people with mostly tax-deferred savings can go either way, and anyone hoping for a quick market pop could go for Obama.