In election years, cocktail parties and family gatherings can become more intense regarding political talk. Whether you align with the red, blue, or independent parts of the political spectrum, many investors from all sides fall into the trap of attempting to “time the market” based on predictions about who will win or lose the White House. Why does this approach tend to work so poorly? It relies on two faulty assumptions or biases.
The first revolves around emotions. Like all humans, investors have emotions and feelings that can be deeply rooted and trigger impulses of fear and greed. Unfortunately, these emotions can lead to speculative investor behavior based on political biases, fear, or greed related to uncertain outcomes. While you may initially be proven right—or wrong—based on short-term outcomes if you attempt to "time the market," historical data tells a different story. History demonstrates that the party in power has little long-term correlation with investor returns in the S&P 500. Based on the data, there is very little long-term correlation in the relationship between S&P 500 index returns and the party in the White House.
The next unstable investing foundation is recency bias. This concept suggests that the most readily available information carries the most weight. Often, this means that we expect outcomes similar to the positive or negative events we most recently experienced or that we easily connect what just happened to what may happen again. However, markets often respond to new factors and inputs rather than old ones, which can lead to dramatically different outcomes that we may not accurately anticipate if we are overly focused on the past.
What is the best antidote to our biases? Education. A properly constructed portfolio should be based on the client's objectives and should consider time horizon; age; tax situation; risk tolerance, willingness, and ability (they are different); income-to-expenses; cash reserves; job security; and a host of other dynamics and goals. Simply put, our emotional and cognitive biases should be checked against data before making decisions. Instead of basing choices on fear, greed, or recency, we want our investing decisions—like our election choices—to be based upon long-term fundamentals and an alignment with each of our unique situations in life.
About the author:
Sam McGee, CFA, MBA, is a Boerne resident and Crestmont Private Wealth (CPW) CEO and owner. CPW has offices in Houston and Boerne and caters to clients who desire a holistic fiduciary wealth management firm to attend to their unique needs. McGee volunteers as a board member for Hill Country Family Services, a Boerne Little League coach, a volunteer firefighter with the Boerne Fire Department, a Skywarn Spotter, and is appointed by the governor to the Firefighters' Star of Texas Award Advisory Committee. He and his wife, Kristen, have two children attending Boerne ISD schools. They enjoy volunteering in the community and spending time with family and friends.
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