Wednesday, April 6, 2022

Recency Bias

A powerful bias in investing is Recency Bias. Recency bias is the tendency to think that things that have happened recently are more likely to happen again or that a current trend will continue despite data and information to the contrary. Recency Bias can show up in many areas of our lives. People who have been in a serious automobile accident may drive more cautiously for a time. Someone who had a winning lottery ticket may be more inclined to buy more lottery tickets. Recency bias can be based on life experiences and our emotions. Following news of an airplane crash, some will choose not to fly despite evidence that flying is the safest form of transportation. People may be apprehensive about going into the ocean if a shark attack has recently occurred, even if the attack occurred hundreds of miles away. As time passes, if there are no more airplane crashes or shark attacks, the emotions and effects of recency bias fade.

Investors often underperform their investment benchmarks due to Recency Bias. During a bull market, investors may ignore data that suggests they should reduce their equity exposure, preferring to believe that the current upward trend will continue. Investors may also ignore positive economic data during periods of market weakness out of fear that the recent downward trend will continue. The best time to reduce equity exposure would be when markets are at highs, but that doesn’t feel comfortable. The best time to reengage with equity markets would be when markets are at their lows, but that won’t feel comfortable either. The SEC disclosure “Past performance is no guarantee of future results” cautions investors against relying on Recency Bias. Experience has taught me not to try to guess about market highs or lows and to pay more attention to the data and less to my feelings and hunches.

Recency Bias can affect our decisions even when events aren’t so recent. When made aware of a coming hurricane, people who live in the affected areas may choose to evacuate or not evacuate based on their experience with previous storms when they should evaluate the risks of the current storm based on the available data and information. When recession and inflation are in the news, people reflect on their most recent experiences during earlier times of recession and inflation though the economic fundamentals and ultimate outcomes may differ.

We can’t eliminate biases from our decision-making processes, but being aware of them and considering how much weight to give them will help us make better life and investment decisions.