Politics Shapes The Average Investors Allocation Decisions

Everything in life is political, including decisions made by ordinary stock market investors. A new study of the behavior of 60,000 retail investors has found that investors are more confident when their political parties are in power in Washington.

On the other hand, when their parties are out of favor investors lose confidence in the U.S. economy, buy more international stocks, and trade more frequently, the study found. Even more disturbing, the loss of confidence and more frequent trading leads the average investor to poorer returns when his party does not prevail.

Political Climate, Optimism, and Investment Decisions" used trading records of 60,000 individual investors from a major retail broker to correlate the investor's trading decisions with the fortunes of their favored party, whether they were Democrats or Republicans.

Although the investors' names and personal information remained confidential, the researchers had each investor's zip code. They used local voting data to infer which party the investor be-longed to. Although the correspondence of investor to party was not precise, it was close enough to establish patterns, said the three researchers from the University of Southern Mississippi and the University of Texas at Austin.

Investors increased their holdings of U.S. stocks when their parties were in power, and were more likely to buy and hold their investments, indicating confidence in the domestic economy, the study found.

When their parties were out of power, investors shifted more of their money overseas or into safer domestic stocks. "Further, when the opposite party is in power, investors lower their forecasts of market returns," the researchers wrote. Conversely, extra optimism by those whose party is in power seems to lead to higher returns.