The Hidden Risks of Copying Congressional Trades

When exploring investment strategies, some investors consider copying the trades of high-profile figures, such as members of Congress, under the assumption that these individuals have access to privileged information that can lead to above-average returns. However, a deeper analysis reveals that this approach may not be as advantageous as it seems.

When aggregating the transactions of all members of the House and scrutinizing the entire portfolio of stocks they bought and sold, the data indicates that these political figures have, in fact, underperformed the S&P 500 throughout the observed timeframe.

The graph below illustrates this phenomenon clearly. It compares the accumulated average portfolio returns of Congressional members against the accumulated returns of the S&P 500, demonstrating that the overall legislative body’s stock market strategies did not yield the superior results that one might expect.

The Myth of Beating the Market

A common misconception is that all politicians beat the stock market due to their privileged access to non-public information and strategic acumen. However, when we examine the broader data of all senators and representatives, it becomes clear that their performance does not consistently surpass the S&P 500. This is strikingly similar to the broader trading population, where reports suggest that as many as 80-90% of active traders fail to outperform this benchmark index over an extended period. In essence, the overall performance of Congress in the stock market mirrors the average investor’s struggles to achieve positive alpha against established market indices.

The Lure of Copying the “Winners” in Congress

Following the revelation that politicians as a group do not outperform the market, a friend might suggest a seemingly more refined strategy: why not just copy the most successful traders in Congress? Surely copying only the “winners” would yield better results. However, this approach is fundamentally flawed due to the presence of several biases inherent in financial decision-making.

The Bias Trap in Financial Strategy

In finance, the term ‘bias’ refers to systematic errors in decision-making that can lead to investment inefficiencies or losses. Let’s explore some of these biases to understand why simply copying the winners in Congress could be misguided:

1. Lookahead Bias: Lookahead Bias actually materializes when an investment strategy is retrospectively deemed successful by cherry-picking data from a subset of individuals, such as politicians, who have had exceptional investment returns. In the context of copying Congressional trades, Lookahead Bias occurs because you cannot predict which lawmakers will generate positive alpha in advance. If you conduct a backtest considering only those few politicians who have had remarkable performances in the past, you would fall into the trap of Lookahead Bias. This is because your analysis benefits from hindsight, assuming you could have identified these top performers from the start, which is not possible in real-time decision-making.

2. Survivorship Bias: By focusing only on the successful trades or traders, you ignore all the failed investments and those individuals who did not perform well, which can skew your perception of the overall success rate.

Relying on the stock picks of Congressional members for investment insight might appear to be a savvy move, but it is filled with biases and potential missteps. Grasping the inherent risks can shield investors from the fallout of a poorly thought-out approach. Here at our website, we aim to guide investors away from the metaphorical “siren’s song” of seemingly attractive but misleading strategies. We delve into investment possibilities with a critical eye to distinguish between the myths and the genuine opportunities. There’s no universal solution for investment success, but armed with knowledge, diversified assets, and a vision for the long term, investors can establish a strong foundation for their financial endeavors.