“ The best antidote to your biases is to subject your beliefs to a reality check from others who don’t share those biases. ”
If you’re a fan of Donald Trump, you’d do well to pick a financial adviser who voted for Joe Biden.
That isn’t because advisers who vote Democratic are better than those who vote Republican. If you are a fan of Joe Biden, it benefits you to find an adviser who votes Republican.
The reason is that our political beliefs unconsciously influence our investment decisions, and in a big way.
When you and your adviser share the same unconscious bias, you’re likely to reinforce each other’s beliefs and pursue even more extreme strategies. When, instead, you and your adviser have differing political views, you provide a reality check to the other. It’s a good sign if the two of you nevertheless can agree on a course of action.
This is the fascinating implication of a study published last Fall in the Journal of Finance. Entitled “Belief Disagreement and Portfolio Choice,” it was conducted by Maarten Meuwis of Washington University in St. Louis and Jonathan Parker, Antoinette Schoar and Duncan Simester of MIT.
The researchers focused on the portfolio changes made by a large group of investors in the wake of the November 2016 election, when Republican Donald Trump beat Democrat Hillary Clinton. The researchers segregated investors into two groups according to whether the majority of voters in a particular ZIP code went for Trump or Clinton. Investors from Trump-favoring ZIP codes increased their equity allocations after the Election, on average, while those from Clinton-favoring ZIP codes decreased theirs.
Though the researchers focused their study on the 2016 election, prior research had found that a similar pattern emerges when the Democratic candidate wins the U.S. presidency, with Democratic investors increasing their equity exposure and Republican investors decreasing.
In other words, investors of both political parties are guilty of this unconscious bias, believing the economic future is brighter when their favored candidate wins and believing that future to be bleaker when their candidate loses.
There is no rational explanation for these results. Over the past century there has been no significant difference between the U.S. stock market’s risk-adjusted performances during Democratic presidencies and Republican ones. Which means that neither Democratic nor Republican investors do better in the stock market, on average over time. The differences in their reactions to presidential elections are caused by unconscious political bias rather than economic fundamentals.
Financial professionals are biased, too
Because the database the researchers analyzed contained both retail investors as well as financial professionals, you might wonder if the study’s results were driven by the former, who are notoriously irrational. Surely financial professionals are less guilty of unconscious political bias?
No. Consider another study that also was published recently in the Journal of Finance. Entitled “Partisan Professionals: Evidence From Credit Rating Analysts,” the study was conducted by Elisabeth Kempf of Harvard University and Margarita Tsoutsoura of Washington University in St. Louis. The researchers analyzed the behavior of hundreds of credit analysts at Fitch, Moody’s, and Standard and Poor’s between 2000 and 2018. They found that “analysts who are not affiliated with the U.S. president’s party downward-adjust corporate credit ratings more frequently.”
The bottom line? It’s a safe bet that each of us is guilty of unconscious political bias, and the same goes for financial professionals. Our biases have a significant impact on the investment strategies we pursue.
The problem with unconscious political bias, of course, is that it is unconscious. That’s why we are unlikely, on our own, to identify its presence or its consequences. The best antidote to your biases is to subject your beliefs to a reality check from others who don’t share those biases. If the assumptions behind your portfolio strategy can’t survive such a reality check, then that is a warning sign that you may not want to bet heavily on that strategy.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com
Plus: The bank panic of 2023 could be just what the stock market needs to make money for investors again
Also read: Does your personality determine your success as an investor?