Why Your Political Views Might Be Hurting Your Investment Returns

One of the main concerns among voters in the 2024 election was the economy, how bad it was, and how we needed a leadership change to fix it. The marginal voter desiring change broke for Trump.

But what has changed economically since the election?

Nothing.

Donald Trump is not the President yet, and the U.S. economy still operates under Biden’s fiscal and legislative agenda.

And yet…

This is a classic example of the Halo and Horn Effect.

Halo

When you like one aspect of a person, you tend to like all other aspects of that person and overrate their abilities, even if you've never witnessed these attributes.

The example below is taken from Thinking, Fast and Slow.

You meet Jane at a cocktail party. Jane is personable and easy to talk to. You enjoyed your brief time with Jane. Then later on someone running a charity asks you how generous Jane is and how likely Jane will donate to their charity. You will most likely rate Jane as very generous and very likely to donate to the charity.¹

But how do you know this?

You know nothing about Jane's generosity. You only really know that Jane was friendly and personable. You overrated Jane's level of generosity because you liked her.

Horns

The opposite is the horn effect, where you undervalue someone's abilities and dislike all their qualities based on a single trait.

Take Tom Brady, arguably the greatest NFL quarterback ever. Ask a die-hard New York Jets fan about Brady, and you'll hear how overrated he is—that he wasn't really that good, that he merely benefited from a system rather than from raw athletic talent. And you'll most definitely hear, "He's a cheater!"

Now imagine if Brady had played for the Jets and won 6 Super Bowls—what would those same fans say then?

Brady's only sin in the eyes of Jets fans is that he played for their hated rival.

Halo, Horns, & Your Money

As shown in the BlueSky post above, your political affiliation can have an unintended impact on your financial well-being and investment portfolio.

From the paper Political Climate, Optimism, and Investment Decision.

In our main empirical analysis, using the Gallup data, we show that Democrats (Republicans) become more optimistic about the stock market and the overall economy when Democrats (Republicans) come to power and there is a decline in optimism when the opposite party comes to power.

Investors tend to increase their exposure to risky more volatile assets when their political party is in power and decrease their exposure when the opposite party is in power. This has the effect of increasing the investors' returns over time, but not for the reason they think. The casual investor will attribute the performance to their political leader. In reality, increasing their risk exposure simply increases their odds of having higher returns in their portfolio, regardless of which political party is in power.

The Halo and Horns effect is another mental heuristic we use to make quick decisions. It is a form of pattern recognition that often produces irrational and heavily biased decisions that tend to harm us financially.

It is hard for us to tell when we are making an irrational decision based on simple heuristics like the Halo and Horn effect. There is no easy way to counteract it. But the first step is to slow down your thinking. Create a checkpoint to revisit your decision and reassess whether it’s a rational one or an emotional one. Self-assessment is hard so you’ll probably need to add a devil’s advocate to question the rationale for your decision.

Secondly, focus on what you can control in the investment process: your research, portfolio management rules, and asset allocation.

This doesn't mean we should ignore presidential economic policies. While Trump's attempt to revive mercantilism in the 21st century is concerning, we must consider: Which proposed policies will actually become law? What's their timeline for implementation? And how long before any negative effects would materialize?

Given Trump's focus on appearances and his view that a strong stock market signals economic success, could he implement other policies aimed at boosting equity markets?

I don’t know, and most importantly, neither do you.

The stock market is a complex, dynamic system with millions of participants. Its reactions to news and economic events are notoriously difficult to predict.

Again, focus on what you can control and invest according to where you can find the best risk-adjusted returns, given the current environment.