Impact bias, a cognitive bias, is the tendency to overestimate the intensity or the duration of future emotions and states of feeling. This overestimation can occur for both positive and negative feeling states. (Psychology Glossary)
You’ve probably heard the expression “I’d rather be dead.” For most people it’s an extreme case of “impact bias.” For some it may be an indication of severe depression or worse. If that’s the case for you, please seek professional advice. Don’t wait. You might like to read a past Think in the Morning blog: First, Choose to Stay.
Most people do not actually want to die even when terrible things happen. This seems to be as true for those who experience life-changing injuries such as paralysis, loss of limbs, etc. and for those who experience financial or relationship setbacks. It appears that the initial reaction to a large disappointment is to feel that “the glass is half empty.” Over time, however, most people come around to the idea that “the glass is half full” and go on with their lives. Harvard psychologist Daniel Gilbert wrote about this in his well-regarded book Stumbling on Happiness. Given the current election confusion, this might be a good time to read Gilbert’s book. A short summary with some anecdotal examples can be found in How To Be Happy When Everything Goes Wrong.
Another book that indirectly touches on the subject of impact bias is Jennifer Hecht’s book The Happiness Myth. One lesson I learned reading Hecht is not to take events (or yourself) too seriously.
This morning many of you are closely watching the election results. There is nothing wrong with paying attention to what’s going on around you, but it’s neither healthy nor wise to stress too much over something the effects of which will likely fade over time.
Below is a slightly revised article I wrote in 2004 that touched on this topic. It was published in The Real Estate Magazine under Notes From A Financial Planner.
Will You Be Happy If Your Candidate Wins?
Most people think investors prefer Republicans. Perhaps they do, but if so it may be for the wrong reasons. For example, take the economy. It may surprising to many people, but Democratic presidents and their administrations have produced better economic results than their Republican counterparts. Of course, Republicans will point to the Reagan years as a period of strong job growth, real wage growth, and economic expansion. In economic terms the eighties were positive years but part of the reason may be simply that the economy was at the bottom of a deep recession when Reagan took over and was bound to recover almost in spite of itself. (see Reagan v Trump Macro Initial Conditions).
One study covering the period from 1871 to 1997 conducted by the Federal Reserve Bank of San Francisco found that the stock market provided better returns under Democrats than under Republicans. (USNews.com, “A Sure Bet,” Jan. 19, 2004) “The evidence indicates slightly, but statistically significant, higher returns during Democratic administrations,” the Fed report stated.
In another widely quoted article by two finance professors at UCLA, (“Political Cycles and the Stock Market” by Pedro Santa-Clara and Rossen Valkanov, Journal of Finance, Oct. 2003) excess market return for the period between 1927 and 1988 was higher when Democrats were in the White House. While this period spans many different administrations and economic conditions, all Democratic administrations show the same effect with the exception of Franklin D. Roosevelt’s second term from 1937-1941. (For updated data read: “Presidential Stock Market Returns, Global Macro Monitor.)
On the economy, the case is also very strong for the Democrats. According to some of the most commonly used measures of economic growth (www.eriposte.com, “Democrats v. Republicans on the issue of the US Economy,” Oct. 2, 2003) the economy was generally stronger under Democrats than their opponents. Inflation, for instance, which reeks havoc on bonds, was lower under Democratic administrations than Republicans for the period 1962-2001 or even from 1948-2001. Other key metrics, such as GDP, unemployment and percentage growth in total federal spending, were all better under the Democrats.
Wealthier citizens (traditionally Republicans) depend more on interest income. According to the data, lower real interest rates accompany a Democratic election and this may impact the cash flow of investors who live on the interest from their bonds. However, lower interest rates may also result in higher prices for outstanding bonds.
Investors are legitimately concerned with risk on their investments but the studies show there is no increase in the stock market’s risk profile under either administration.
Obviously past performance of the capital markets and the economy is no guarantee of future results. No matter the party that resides in the White House, a highly diversified portfolio matched to individual risk tolerances is a sensible strategy over many election cycles.
At its core, Republican administrations tend to favor higher defense spending, lower entitlement spending, and lower tax rates that. Republican administrations have generally stressed freedom of enterprise and less government regulation in the economy although they have strayed from these goals in social and cultural areas such as abortion and gay rights.
The rest of this year will almost surely be dominated by politics. One positive aspect of such political focus is that many of us will become more aware of and involved in the political process and in the economic environment that accompanies that process. One downside could be that, as a country, we become more divided and that the compromises within our cultural melting pot that have made our political and economic systems so strong become more difficult to achieve.
Investors will be best served if they don’t put too much weight on either the positive or negative aspects of investing in an election year. Contrary to popular opinion, the Federal Reserve has raised interest rates in 5 of the last 8 Presidential election years and while there is no indication that they will raise rates before the election, it is not out of the question. According to Yale Hirsch in his Stock Trader’s Almanac, election years have been the second best year for stocks in the four-year Presidential cycle although one should remember that stocks lost money in 2000, the last election year.
People often overestimate the impact of future events on their lives. They predict current events will have a more intense and more enduring impact on their personal lives than they actually do. Psychologists call this the impact bias. Harvard Psychologist Daniel Gilbert writes: “We’ve done dozens of studies in both the laboratory and the field, and the general strategy of the research is really very simple: We ask people to predict how they will feel minutes, days, weeks, months, or even years after some future event occurs, and then we measure how they actually do feel after that event occurs. If the two numbers differ systematically, then we have one of those interesting and unusual systematic errors I mentioned. We’ve seen the impact bias in just about every context we’ve studied. For example, we’ve studied numerous elections over the last few years, and voters invariably predict that if their candidate wins they’re going to be happy for months, and if their candidate loses they’ll be unhappy for months. In fact, their happiness is barely influenced by electoral outcomes.”
Will you be happy if your candidate wins? In the short run probably, but not as much as you think over the longer term. This is not a reason to ignore the election. I have voted in every election since I have been old enough to vote. I have always had an ongoing interest in political matters and believe that voting is a required responsibility of everyone living in a democracy. But, your investment portfolio should be constructed carefully enough to survive not only politics but all the other factors that influence the financial markets including the unknown. Proper diversification and a long-term focus have been sensible strategies in the past. Scrambling to find the best investments in an election year is not likely to help with that construction process.