What to Tell Clients in a Nasty Election Cycle

How Political Confirmation Bias Leads to ‘Misbelief’

Politics has always been a bit nasty. There’s nothing new about that. The polarization we’re seeing today is not new either; we lived through similar times 160-plus years ago, during the pre- and post-Civil War days.

Historically, what we’ve seen in times like these is that the extreme left and right create a lot of noise, while the moderate majority is drowned out:

Common wisdom might expect political inclinations to resemble the curve depicted above. However, much like the yield curve on interest rates, today the chart may be inverted, or be a U-shaped curve, with few moderates remaining as people move toward the left and right.

This trend is readily apparent in social interactions, where most of us are reluctant to bring up politics unless we know that th other person’s positions agree with ours.

Although most Americans may not like either of the two presidential candidates, or politicians in general, we still tend to demonize the opposition. Because we get our news from sources that confirm our existing beliefs, we create, as we do in investing, something called confirmation bias.

In his book “Misbelief,” behavioral economist Dan Ariely explores this tendency to demonize others and how it results in beliefs that other people will view as absurd. He finds these “misbeliefs” are prevalent among both the left and right political spectrum. His research also shows that even the most extreme misbeliefs can be held by very intelligent and nice people, and can cause them to display some unthinkable behavior.

Framing Investment Choices as ‘Good vs. Evil’

Let’s face it: None of us is in control of the future. This causes stress and anxiety, particularly when the future is supposedly whatever hellscape your party is telling you will happen if the other party comes to power.

We get a temporary sense of relief by framing all this uncertainty in good-vs-evil terms and finding a villain to blame. So we go to our favorite news site to confirm our beliefs, particularly so that we remain the “good” in this equation. Then we change our social circle to include only those who share our beliefs. This paring down of our social circle occurs both online and with personal friendships, even family.

What should we as advisors do in times where identity politics permeates every aspect of our clients’ lives, including investing? Today, I think many of our clients will want to get out of the stock market, because they are afraid the other candidate they view as a “villain” will win, and his leadership will bring about the demise of all things democratic and economic. How do we get people in that mindset to stay the course?

I think the answer comes down to roughly 20% logic and 80% behavior.

Making the logical argument

First, I give the client some examples of investors who contacted me telling me they got out of the stock market when Obama, Trump, and Biden won the election.

Granted, their typical reaction is, “Things are different today.” I tell them that I agree; however, the stock market also survived the times when politicians settled their differences with fists and weapons, so dueling just with words is actually an improvement.

I also point out that any successful timing of the stock market must be based on knowing something the market doesn’t already know. If that villain wins the presidency and that political party that supports him controls Congress, that fact has already been priced into the market.

Ask the client what they would invest in, if they got out of the stock market. I’d love to ask the “Concerned American” who sent me the letter what he or she would invest in if the dire scenario he or she posed came to pass, since stocks and bonds would tank and the dollar would be worthless. I can only think he might want gold or bitcoin -- not exactly the most stable choices for senior citizens.

Behavioral Nudging: The Case of the Flush Toilet

We are not logical animals, as pointed out by the late Daniel Kahneman. Logic and data can help, but emotions will always rule the day. Though my instinct is to argue the logic, my instinct is wrong.

In his book, How Minds Change, David McRaney says, “The idea is to move forward, make the person feel heard and respected, avoid arguing over a person’s conclusions, and instead work to discover the motivations behind them.” You likely already have a good rapport with your clients, so it comes down to making sure they feel heard by you.

Ariely suggests asking the client if they think a neutral third party would come to the same conclusion as they have. While we may be fiduciaries trying to act in the client’s best interests, we cannot be truly neutral, since we stand to lose if the client jettisons most or all of their portfolio.

This is somewhat generic advice, so I asked Ariely specifically what an advisor should say to the client who is absolutely certain markets will tank. He responded that, “The good news is that people who are 100% sure something like that will happen haven’t thought through their position, so shaking their confidence is easy.”

He gave me an example of an experiment. He showed people a flush toilet, then asked people to rate their knowledge of how a flush toilet worked. On a 10-point scale, most people rated themselves very high -- often a nine or 10. Then, he showed them all of the parts of a flush toilet and asked them to assemble the toilet using the parts. Few could. He then asked those same people to again rate their knowledge on how a flush toilet worked; this time, they rated themselves much lower than before.

What does this example have to do with investing? We know that, over the past 10 years ending April 11, 2024, the total U.S. stock market gained an average of 12.5% annually. At the same time, the last decade brought us a pandemic, wars, surging deficits and debt, near-record inflation, political dysfunction, as well as other endless depressing news. Like the analogy of the flush toilet, I certainly can’t put those facts together to build the case for why U.S. stocks had such a stellar decade. And, of course, the last decade included three presidents: Obama, Trump, and Biden.

So I tell clients that, if we can’t even explain the past, just think how difficult it is to predict the market’s future. The stock market is a complex organism, one that no one has the ability to predict.

Other Tips to Managing Client Fears

Ariely also suggests asking the client for additional details. For instance, ask the client when the market will plunge and by how much, or how will international stocks perform compared to the U.S. More detailed questions may shake their confidence in their doomsday scenarios. Write all of this down, then later point out the inaccuracies of their predictions.

Another option is to appeal to their pain of paying taxes. Because stocks have surged and unrealized gains have mushroomed, many clients stand to incur a hefty tax bill if they sell willy-nilly. So calculate an estimate of the tax bill such selling will create. Their logic may dictate that it’s better to sell before the collapse, but pointing out the certain loss from the tax consequences would at least test their belief that stocks are likely to plunge. Quantifying the certain loss from taxes today will carry a lot of weight. People can become more risk-seeking when faced with a certain loss.

One final argument I tell clients is that if the market does plunge, and we get a real grizzly bear market like the 35-year bear market we’ve seen in Japan, then I’m going down with them. People hate to lose money, but I’ve found they hate it a bit less if they know others have lost as well.

The Changes I’m Not Making Based on the Election

I’m not planning on making changes to my portfolio, nor am I recommending any changes to clients, based on election polls or outcome. That doesn’t mean I won’t use clients’ emotions to nudge them toward what I think is a better portfolio.

For example, with U.S. stocks surging, I recommend rebalancing, which is easier to do for someone who is pessimistic about the market. These days, most clients come to me very light in international stocks, and their fear of U.S. stocks plunging can be used as an argument to diversify to hold more international stocks. While correlations are high, magnitudes are very different.

Generally speaking, I am quite worried about the state of our politics and our inability to work together to solve problems. I am also worried about our ever-increasing national debt, which I don’t see either party addressing in a meaningful way. But as I mentioned earlier, all this dysfunction is already reflected in the market. I don’t know anything that isn’t already known to the market, and I’m 100% sure that I don’t know the future. So I’m telling clients to recognize that they don’t either and not to factor politics into their investing. In my view, there’s never been a better time to stay the course.

Allan Roth is the founder of Wealth Logic, LLC, a Colorado-based fee-only registered investment advisory firm. He has been working in the investment world of corporate finance for over 25 years. Allan has served as corporate finance officer of two multi-billion-dollar companies and has consulted with many others while at McKinsey & Company.

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