By Peter Mastrantuono
Recency bias is a cognitive bias that places greater importance on recent events versus historical experience. It can occur in many settings, e.g., a boss conducting an employee evaluation that emphasizes an employee’s performance in the last several weeks versus the full six- or 12-month evaluation period or jurors giving greater weight to closing arguments over the evidence presented during the course of a trial.
Recency bias also affects individuals’ investment decisions.
One of the most pervasive expressions of recency bias is projecting investment performance. We tend to view the recent performance of a fund, portfolio manager or asset class as indicative of how it will perform in the future, leading many investors to buy into the moment’s “hot” manager, fund or trade (e.g., FANG).
Recency bias also affects investors’ risk perceptions. When markets are rising, investors tend to see less risk in the market and become more enthusiastic buyers. Conversely, in down markets investors see greater risk and often sell or remain on the sideline.
In either case, recency bias can lead investors to make short-term decisions that deviate from their long-term financial plan and hurt their chances of achieving their financial goals.
According a 2020 survey of financial advisors, recency bias was the most common behavioral bias affecting their clients’ investment decisions. The survey found that recency bias is most prevalent in the decision-making of Millennials, perhaps because they have the least direct investment experience and education.
Recent events have put a spotlight on the harm that recency bias can inflict. According to data from Charles Schwab, the S&P 500 declined nearly 20% during February-March 2020, leading to over $1 trillion of flows into money market funds, resulting in many investors missing out on the nearly 18% rebound in April-May 2020.
Overcoming Recency Bias
There are several steps investors can take to prevent the mistake of taking actions based solely on recent events.
Take a Deep Breath and Reflect: When tempted to chase rising markets or abandon stocks in down markets, take a moment to review your financial plan, as well as the historical performance of the asset classes in which you are invested. Such reflection will be an important reminder that you constructed a sound plan for achieving your important financial objectives, providing you the resolve to not bend to the moment.
Speak with Your Financial Advisor: The value of a financial advisor is not only in building portfolios and financial plans, but it also resides in keeping you from taking actions that will damage your long-term financial success. A conversation with financial advisor can help keep events in perspective and maintain your focus on the long-term.
Ignore the Noise: Tune out and turn off all the noise that usually accompanies a bad market downturn or a wild bull market run. Overconsumption of recent news is sure to inflame recency bias. Instead, limit your time watching business and market news to avoid getting caught up in the whirlwind.
Construct Mental Obstacles to Action: If you can create friction in your investment decision-making, it may help reduce your reactions to recent events and slow down bad decisions. For example, considering the tax consequences of selling stocks before putting in a sell order.
Another mental obstacle is reminding yourself that someone is buying what you’re selling. Take the time to make a case for why that investor is buying. You may discover that building that case for buying keeps you from selling.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.