Investors have a lot on their minds these days, from trade negotiations to geopolitical tensions to a potential global economic slowdown and possible recession. There’s also a U.S. presidential election on the horizon, adding political noise to investors’ desire for clarity and understanding. Investor perceptions of risk and reward influence the decisions they make in their portfolios — and political leanings can distort these perceptions.
Politically inclined investors tend to see the markets as less risky and more attractive when their preferred party is in power. In contrast, those whose party is out of power are likely to feel more pessimistic and see greater risk in the markets.
In this age of information abundance, how should investors read and use the news for their benefit? Tune out the noise if you’re looking for prudent guidance and actionable insights. Then, pay attention to the fundamentals, which have a bigger influence on market value than the fickle winds of the political climate.
Markets can turn volatile as investors shift their sentiments to align with their political inclinations. But like most external forces, these fluctuations have little long-term impact on the financial markets.
Political Tribalism: A Combustible Mix
Mark Twain once said, “Never talk about politics or religion in polite company.” He could have added money to that list as well.
People tend to have strong feelings about both politics and money. There’s nothing inherently wrong if someone holds strong political beliefs, but it’s important to recognize the influence strong political views can have on different decisions we make, including how we invest money for the future.
This is a critical topic for financial advisors and investors to discuss because political tribalism — which is when people with strong political beliefs self-segregate into tribes of like-minded individuals — is at a high point right now. In fact, recent surveys by the Pew Research Center show that political tribalism is stronger now than it was 25 years ago. Around 45% of politically inclined people — both Democrats and Republicans — hold very unfavorable opinions of the other party.
Investing Under the Influence
The absence of diverse or challenging viewpoints can have an undue influence on investors who live inside these ideological bubbles. Loyalty to the “tribe” can distort their judgment and lead to emotional decisions that run counter to their personal investment objectives.
Research on the role of politics in investment decisions found that politically minded investors tend to be more optimistic about market opportunities when their preferred party is in power. As a result, they may take on more risk than they should and expose themselves to potential losses if the market falls.
Conversely, investors whose political party is out of power exhibit greater pessimism about the future. As a consequence, they may pull assets away from the market to lower their exposure to risk. But the greater risk these investors face is missing out on market gains.
Investors under the sway of political tribalism may see a connection between politics and investment that in reality does not exist. Market history shows that stock returns have been good under both Democratic and Republican presidents. Even one-party legislative control has had no discernible effect on market returns.
When politically minded investors connect electoral victories and market performance, confirmation bias is in full effect. For these investors, it can be affirming to believe their deeply held political views translate to financial gain. And politicians may try to link their policies with economic and financial success — it makes for memorable bumper stickers, rousing speeches and favorable headlines.