By Mark Hulbert
Oct. 20, 2020
In this heated political season, most people probably have some idea how their investment choices might change depending on who wins in November. They may think that different sectors might prosper under a different president, or that interest rates would be more or less likely to rise.
But here is something most investors don’t realize: Research shows that their investment decisions will largely depend on simply whether their favorite candidate wins or loses.
For instance, if their favorite ends up in the Oval Office, they will tend to be more confident about the market and take on more portfolio risk. A loss, on the other hand, means that they will tend to opt for safer investments, as they expect the worst from the new administration.
Their choices aren’t necessarily wrong. But they aren’t based on objective analysis. Going with an unexamined gut instinct can lead people to make bad moves and capture lower returns—or do serious damage to their portfolio, the researchers say.
One of the most important studies of political impact on investor behavior looked at the years 1991 through 2002, a period that encompasses three presidential-election cycles.
The study analyzed extensive survey data gathered by Gallup and the trading histories of more than 60,000 individual investors at a major brokerage firm. The researchers—Alok Kumar of the University of Miami, Jeremy Page of Brigham Young University and Yosef Bonaparte of the University of Colorado at Denver and director of that institution’s Global Center for Political Finance—controlled for all the major demographic factors, such as age, race, gender, education, and wealth and income level.
The findings: After the 1992 and 1996 elections, when the Democratic candidate won the presidency, Democratic voters tended to have greater confidence about the future of the economy than Republican voters. That confidence translated into their being willing to incur more portfolio risk, to favor the stocks of domestic over foreign companies and to trade less frequently. At the same time, Republicans were less confident about the economy and therefore tended to do the reverse of what Democratic voters did.
When the Republican candidate won the 2000 election, the opposite pattern emerged: The Republican voters tended to incur more risk, favor domestic companies and trade less frequently.
In fact, the researchers found that both Republican and Democratic voters were guilty of letting their political beliefs and biases influence their investment choices. And the pattern has gotten stronger in the years since 2000 as the nation’s political climate has grown more polarized, Prof. Bonaparte says.
The professors argue that the investors whose candidate lost are making a mistake when they trade more frequently, since that on average leads to a diminution in returns. But the researchers don’t take a position on the merits of any of the other changes made by the investors in their study. The point, Prof. Bonaparte says, is that objectivity is difficult to maintain when we’re gripped by partisan fervor.
“For better or worse, investors are influenced by their political affiliation,” Prof. Bonaparte says.
The pros do it, too
These findings don’t apply only to individual investors. Investment professionals are also guilty of this behavior, according to a study by Jerry Parwada, a finance professor at the Australia Business School of the University of New South Wales, and Amanda Chin, one of Prof. Parwada’s graduate students at the time of the study.
Their research focused on the behavior of institutional money managers in the months before the 2000 U.S. presidential election. They relied on publicly reported campaign contributions to determine the political affiliations of those managers, and on media reports to determine which stocks would likely do better or worse depending on whether the Republican candidate (George W. Bush) or the Democratic one (Al Gore) won.
The researchers found that, in the months leading up to that election, Democratic managers invested more heavily in stocks that supposedly would benefit if Mr. Gore were to win, while Republican managers invested more heavily in stocks that presumably would benefit from a Bush presidency. In other words, both sides let their partisan fervor guide their choices.
We probably shouldn’t have been surprised by these findings, given the extensive research in the fields of psychology and other social sciences that document the difficulty of being truly objective in any area of life. Why should investors not face the same difficulties?
"When the political climate is aligned with their political identity, investors increase allocations to risky assets and exhibit a stronger preference for high market beta, small-cap, and value stocks."
— From the study, ‘Political Climate, Optimism, and Investment Decisions’
Dan Ariely, a professor of psychology and behavioral economics at Duke University, said in an interview that “we know that people’s decisions are very much colored by lots of things that are influencing their view of life.”
Tom Gilovich, a psychology professor at Cornell University, points to studies showing Democrats and Republicans each claiming that the electoral map is biased against them, people thinking that their parents have been harder on them than on their siblings, and academics believing that they have a harder time with journal reviewers and tenure committees than colleagues in other disciplines. And sports fans of both teams in a contest, of course, often feel the referees and the announcers are biased against them.
The best way to counter the influence of biases on our decision making—whether those biases arise from partisan political preference or something else entirely—is to subject our analyses to the scrutiny of others, according to Richard Geist, president of the Institute of Psychology and Investing, and a former member of the psychiatry department at Harvard Medical School.
Don’t stand alone
“Participating in an investment club is one way of doing that,” he told me in an interview, “but you could also pick one or two colleagues by which you run your ideas, or subscribe to the newsletters or blogs of a few respected investment gurus.” (And actually listening to the outsiders’ views, rather than looking for any opportunity to disagree, is part of the equation, too.)
Regardless of where the critical scrutiny comes from, however, Dr. Geist emphasizes that “the key thing to avoid is picking the club, colleagues or gurus simply because they agree with you; instead, you should pick them precisely because they may very well disagree with you.”
If your investment ideas can withstand critical scrutiny from outsiders, then you can be more confident in pursuing them. But if they can’t, you may want to think twice before betting heavily on them. And unpin the election button from your shirt before you start.
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