It is almost Election Day in the US once again and while the outcome may be uncertain, one thing we can count on is that plenty of opinions and predictions will be floated in the days surrounding the vote. In financial circles, this will inevitably include discussion of the potential impact on markets. But should elections influence long-term investment decisions?

We would caution investors against making changes to a long-term plan in a bid to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the collective expectations of those investors. This makes consistently outguessing market prices very difficult.

US elections often bring market volatility, tempting investors to anticipate the outcome and adjust their portfolios. While active fund managers have the flexibility to react to political trends, passive investments – known as index funds and ETFs that track broad market indices—could fare better during election-driven uncertainty. This may seem counterintuitive, but several psychological and behavioural biases often lead active managers astray.

Expectation bias: overconfidence in predictions

One of the most prominent biases affecting active investing during election seasons is expectation bias, where investors place too much confidence in predicted outcomes. Some of the best active managers suffered from this at the 2016 Brexit vote and there is no shortage of predictions this time for the outcome of the US election;

Kamala Harris would continue the clean energy policies of the current Biden administration, whereas Trump has always been more in favour of less interference, which means more in favour of fossil fuels.

Trump’s stated “winners” include Crypto; Harris will likely introduce further legislation for the sector.

On Big Tech, Harris favours increased regulation of the sector, including the possibility of the breakup of Google, whereas Trump has even mentioned specifically that he would not seek to break the company up).

The list is endless, but is it really possible to be perfectly positioned ahead of the event? History tells us it is not.

In the weeks leading up to the 2016 US presidential election many anticipated that a Trump victory would result in a market downturn. When the opposite occurred, those who bet against the market missed out on the post-election rally. Passive investors however, who track the market without attempting to predict political outcomes, avoided this trap and reaped the rewards of staying invested.

Passive investments don’t rely on predictions, which can be risky, especially in the volatile lead-up to an election. By staying invested in the entire market, passive investors avoid the mistakes that often result from overconfidence in forecasts.

Ambiguity aversion: fear of the unknown
Ambiguity aversion is another bias that can negatively affect active investing during elections. This bias refers to the tendency to avoid uncertain situations, even when they might present opportunities. In the context of elections, ambiguity aversion can lead investors to reduce exposure to sectors or industries they believe might be negatively affected by the outcome, often based on incomplete or unclear information.

Passive investors don’t have to navigate the murky waters of political predictions. By holding diversified investments across the market, they reduce the risk of overreacting to ambiguous election outcomes and benefit from broad market exposure.

Confirmation bias: seeking information to support pre-existing beliefs
Confirmation bias is the tendency to seek out information that aligns with one’s pre-existing beliefs while ignoring contradictory evidence. In the lead-up to elections, investors and active managers may fall prey to this bias by favouring news and analysis that supports their political preferences or investment strategies.
Passively, by sticking to a predetermined strategy that reflects the entire market, rather than selectively emphasizing certain sectors based on political views. This diversified approach ensures that investors don’t lose out by focusing too narrowly on a particular outcome.

Behavioural biases and the dangers of market timing
Election volatility often prompts investors to try to time the market, a notoriously difficult and risky strategy. Loss aversion can drive investors to sell prematurely during market dips, while herding behaviour may lead them to follow the crowd into overvalued stocks. Both of these biases can be costly during elections when markets are unpredictable.

Market timing rarely pays off. Even professional investors struggle to time the market correctly, especially during periods of heightened political uncertainty. Passive investors, by contrast, don’t try to time the market. They stick to their strategy, allowing them to benefit from the long-term upward trajectory of the market, rather than getting caught up in short-term political events.

Structural advantages
Passive investments, designed to avoid these pitfalls, tend to deliver better long-term results. Beyond avoiding biases, passive investments offer structural advantages during election volatility. By tracking broad indices, passive funds provide built-in diversification, spreading risk across multiple sectors and industries. This is especially valuable during elections, when different sectors may react unpredictably to political outcomes.

These lower costs are especially important during volatile periods when active managers often incur more trading costs within a structure. With fewer transactional fees to erode returns, passive investors keep more of their gains over time, even when markets are choppy.

While active investing may seem appealing during the uncertainty of an election, passive investments often prove more resilient. Cognitive biases like expectation bias, ambiguity aversion, and confirmation bias can lead active managers to make decisions based on political predictions. In contrast, passive strategies, focused on long-term market growth, diversification, and low fees keep investors on track.

Elections come and go, but the market’s long-term trajectory remains upward. By avoiding emotional and cognitive traps, passive investors are well-positioned to weather election volatility and benefit from the market’s inevitable recovery.

Expert advice

At Blackden Financial we have been advising our clients in Europe for the past two decades on just such matters, so if you feel you may need advice now on how to proceed, book a no obligation ‘discovery’ call. There is no commitment and no cost.

Contact us on +41 22 755 0800, e mail info@blackdenfinancial.com or complete our Contact Form here

One of our team will contact you and arrange a suitable time to discuss whether our service may be suitable for your situation and if so how best to proceed, step by step.