Key Takeaways
- Election years may bring short-term market volatility, but the long-term impact on investment returns is typically minimal.
- Maintaining an investment strategy that is focused on your wealth goals rather than politics can help you avoid emotional investing and alleviate stress.
- Experienced advisors can provide objective viewpoints and reinforce investment strategies that remain aligned with your financial objectives.
With the election year in full swing, investors may feel uneasy about their portfolios and seek clarity amid political turbulence. Yet, history reveals that while elections spark short-term market fluctuations, they rarely warrant dramatic shifts in your investment strategy.
The Psychology Behind Market Volatility During Election Years
Elections and politics matter — of course — but they don’t actually matter much in the grand scheme of investment planning. So, why do we sometimes see volatility during election years?
Short-term markets are largely impacted by human emotions.
Politics, elections, and presidential candidates are not necessarily responsible for market volatility — but investors are. With uncertainty comes the impulse to change course. When more people alter their strategies, make impulsive decisions, and react to external factors, volatility occurs.
This irrational decision-making is especially heightened during election years when several key biases come into play:
- Recency Bias: This is the tendency to give undue weight to recent events. As election coverage dominates the news, investors might overestimate the importance of political developments and assume they will have a more significant impact on the market than they historically do.
- Confirmation Bias: Investors often seek information confirming their pre-existing beliefs. If they are convinced that a particular election outcome will harm their investments, they may focus only on information that supports this view, ignoring contrary evidence.
- Loss Aversion: People tend to fear losses more than they value gains. During potentially volatile periods, such as an election year, this fear can lead to panic decision-making, even if the long-term outlook remains stable.
Media Influence
The media plays a substantial role in shaping investor perceptions during election years. News outlets thrive on sensationalism, often exaggerating potential impacts to attract viewers and readers. This constant barrage of dramatic headlines can exacerbate investors' fears and lead to hasty, emotionally driven decisions.
Investors should be mindful of the media's role in amplifying emotions and strive to filter out the noise.
It’s essential to focus on the fundamentals of investing and the long-term horizon that is aligned with your investment objectives rather than getting swayed by short-term reports.
Understanding Historical Market Trends
Investors often worry that election years will bring significant market instability, driven by the uncertainty of potential policy changes and political shifts. Interestingly, a balanced portfolio has actually, on average, performed better during election years compared to non-election years.
Research dating back to 1860 finds no statistical relationship between the performance of a 60% equity/40% bond portfolio in presidential election and non-election years.
Source: Vanguard calculations based on information from Global Financial Data (GFD).
Additionally, using the S&P 500 Index as a market gauge, consider this: if an investor only allocated funds when a Republican held the presidency and shifted to cash during Democratic administrations, their initial $10,000 investment would have grown to approximately $83,360.22 by the end of Q1 2024. Conversely, choosing to invest exclusively during Democratic presidencies would have increased that $10,000 to around $414,703.12. However, an investor who disregarded political cycles and remained consistently invested would have seen their initial $10,000 grow substantially to approximately $3.46 million by the end of Q1 2024.
Market growth stems from continuous innovation, creativity, and companies’ ability to generate increasing profits. Despite political changes or policies implemented by different administrations, entrepreneurs and businesses have consistently demonstrated their resilience.
Strategies to Maintain Rationality
When building long-term investment portfolios, the focus should be on consistency and stability rather than political events. Over 20 years, very few investors will look back and pinpoint a specific election as having significantly impacted their portfolios. What matters more are the overall performance of companies, the state of the economy, and the market environment.
Investors can adopt several strategies to navigate the psychological challenges of election years and maintain rational decision-making:
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Seek Professional Guidance:
Financial advisors are crucial in helping investors maintain perspective. Advisors can provide a rational, objective viewpoint, reminding investors of the long-term nature of their goals and the historical context of market behavior during election years. -
Stick to Your Plan:
A well-thought-out wealth plan is based on individual goals, risk tolerance, and time horizon, not short-term political events. By committing to the plan, investors can avoid the temptation to make knee-jerk reactions to election news. -
Review on a Consistent Basis:
It is essential to regularly review and adjust the investment portfolio based on long-term goals. However, these reviews should be systematic and scheduled, rather than occurring in response to political developments or market fluctuations. -
Diversify to Mitigate Risk:
A diversified portfolio is less likely to be significantly impacted by any single event, including elections. This reduces the emotional stress of potential losses in one sector or asset class. -
Educate Yourself:
Understanding historical market trends during election years can help demystify the process. Knowing that markets have weathered political storms in the past and continued to grow can provide the confidence needed to stay the course.
Eide Bailly Wealth Helps Smooth Out the Ride
The power of your wealth plan lies in its ability to provide clarity and direction, regardless of external economic or political events. It serves as a roadmap tailored to individual goals — whether saving for retirement, funding education, or building generational wealth. By focusing on these objectives, you’ll be better equipped to navigate turbulent periods with confidence, knowing that your plan is designed to withstand market cycles and economic shifts.
Lessons Learned in Investing — 5 Strategies for an Effective Portfolio
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