Do elections affect the stock market? Last week I cited an analysis by Vanguard Group which attempted to answer this question. The verdict: “It’s understandable to have concerns about the election. But as far as your portfolio and the markets are concerned, history suggests it will be a nonissue.” Specifically, the analysis cited evidence that investment returns are no different in election years than in non-election years.
I agree with Vanguard’s overall recommendation—to stay the course with your financial plan. Especially if you have a long time horizon, I think it makes sense to avoid any drastic action in response to the election. Despite the historical data, though, many investors are still feeling anxious because of this year’s unique circumstances. That, unfortunately, is the nature of data. It is necessarily backward-looking while forecasts are all forward-looking. And the future is never exactly like the past. So it’s understandable to still be feeling worry. I would be kidding you if I didn’t acknowledge feeling uncertainty myself.
While I can’t offer an antidote to uncertainty, I do think understanding more about it can help in managing through it. Below are a few observations from the academic research that may be helpful:
1. There may be nothing worse. Neurologist Archy de Berker once conducted experiments to measure people’s aversion to uncertainty. He did this (as scientists seem to enjoy doing) by administering mild electric shocks. His conclusion: “Knowing that there is a small chance of getting a painful electric shock can lead to significantly more stress than knowing that you will definitely be shocked.” In other words, uncertainty about the potential for something bad is actually worse than the bad thing itself. So if you’re feeling anxious about everything that’s going on—and the potential impact on your finances—it’s understandable. But what de Berker’s research tells us is that the fear is usually worse than the reality.
2. The thing you’re most worried about may not be the thing most worth worrying about. If you think back to the spring, when Covid started, you’ll recall how the stock market dropped like a rock—down 35% in a matter of weeks. And yet, over the subsequent six months, the market fully recovered. Why has it bounced back even though Covid is still with us? One reason is that we have greater certainty now. The government stepped in to support the economy, and drug makers are busy working on vaccines. Yes, Covid still presents a big risk, but we have a clearer picture than we did six months ago. What this episode teaches us is that the things that present the biggest risks are the things that we’re not currently thinking about. It’s the things that catch us by surprise, as Covid did, that pose the biggest risk to markets. But, by definition, we don’t know what the next surprise will be. For that reason, I advise structuring your finances—to the extent possible—in an all-weather sort of way. In other words, even when it looks like smooth sailing in the economy, maintain caution. This includes, for example, rebalancing and maintaining an emergency fund even when neither may feel necessary.
3. Some of us are more bothered than others by uncertainty. In 1990, psychologist Arie Kruglanski developed the concept of “need for closure” and observed that people differ in this regard. While no one likes uncertainty, some dislike it more than others. Kruglanski actually developed a scale and an assessment tool to measure this. You can find these online, and you might find them interesting. While any online assessment will be imperfect, I do think there’s value in knowing where you fall on this scale—especially if you’re married and you find that you’re thinking about (and worrying about) current events differently.
4. Uncertainty nags at us. Think about a TV show that ends in a cliffhanger. TV producers do this because they know viewers will almost certainly tune in for the next episode. When something is left unresolved, we can’t stop thinking about it. This presents a problem for investors. The longer uncertainty lingers, and the more we perseverate about it, the more we may feel compelled to take action. My advice: Even if you’re feeling a lot of anxiety, try hard to resist this temptation. Market timing rarely works out well.
5. Uncertainty is so unpleasant that we are quick to latch on to explanations. Psychologist Daniel Crosby explains that uncertainty can push investors into one of two camps: Some assume the worst and engage in what he calls “catastrophizing.” Meanwhile, others become over-confident. For those in this second camp, Crosby says, “Our discomfort with uncertainty can make us just pretend that it doesn’t exist and pretend that we know exactly what’s going to happen.” The danger here is that these are both extremes. Moreover, neither camp knows what’s actually going to happen. But because they’re speaking in extreme terms, their stories may sound convincing. My advice: As we get closer to the election, try to keep both feet on the ground and avoid getting swept up in prognostications of any kind.