DO ELECTIONS affect the stock market? Last week, I cited an analysis by Vanguard Group that attempted to answer this question. The study’s 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, Vanguard’s 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. I think it makes sense to avoid drastic action in response to the election, especially if you have a long time horizon. But despite the comforting historical data, many investors feel anxious because of this year’s unique circumstances, and I must confess to feeling some uncertainty myself.
While I can’t offer an antidote to uncertainty, I think it’s helpful to understand the concept better. Here are five observations from the academic research:
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. If you’re anxious about everything that’s going on—and the potential impact on your finances—it’s understandable. But de Berker’s research tells us 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. Think back to the spring, when the pandemic started. You’ll recall how the stock market dropped like a rock, with the S&P 500 down 34% in a matter of weeks. And yet, over the subsequent six months, the market fully recovered. Why has it bounced back even though COVID-19 is still with us? One reason is that we have greater certainty now. The government stepped in to support the economy, while drug makers are busy working on vaccines.
Yes, COVID-19 still represents 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 risk are the things that we aren’t currently thinking about—the things that catch us by surprise, as the pandemic did. Problem is, by definition, we don’t know what the next surprise will be. For that reason, I advise structuring your finances to weather all sorts of scenarios. That means being cautious, including rebalancing occasionally and maintaining a healthy emergency fund, even when such steps seem unnecessary.
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 developed a scale and an assessment tool to measure this. You can find these online. While any online assessment will be imperfect, I think there’s value in knowing where you fall on this scale—especially if you’re married and you find that the two of you are perceiving and worrying about current events differently.
4. Uncertainty nags at us. Think about a TV show that ends with 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 dwell on it, the more we may feel compelled to take action. My advice: Even if you’re feeling a lot of anxiety, resist the temptation to act. Market timing rarely works out well.
5. Uncertainty is so unpleasant that we’re 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 overconfident. 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 reality: Neither camp knows what the future will bring. 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 your feet on the ground—and avoid getting swept up in prognostications of any kind.
Adam M. Grossman’s previous articles include When to Change, Just Say No and Eyeing the Exit. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.