Recency Bias in Investing
As I watched footage of hurricane Ian wreaking havoc on the Florida coast, my four-year-old daughter asked what was going on. I gave her a brief explanation about what a hurricane is and was sure to include the point that, fortunately, they aren’t something that happens in our area.
Later that day, however, when we were planning a walk at Boulevard Park (right on the coast, for those of you who aren’t local to Bellingham), she didn’t want to go. She was afraid of a hurricane. It didn’t matter to her that I explained the hurricane she saw on TV was 3000 miles away- the image blocked her four-year-old logic and her belief had been framed by her most recent memory: hurricanes exist near water, and they are scary.
My daughter was being swayed by something known as recency bias. Recency bias is a shortcut our mind takes to help us make everyday decisions without wasting brainpower. Our default thought process is lazy, overemphasizing the most readily available data and assuming that the future will continue to play out in the same direction as it did most recently.
This predisposition serves its purpose when it comes to mundane choices. “Yesterday this road had traffic, I’ll try a different route today,” is not a high-stakes decision. Using our most recent information in this way allows us to act quickly and with minimal consequences if we are wrong.
However, when attitudes based primarily on recent information impact high-stakes decisions with long term implications, such as investing, it can create problems.
“The market has been down for two quarters; I will cut my losses and move to cash” is an example of an error in logic that recency bias would have us make with our financial decisions.
This example exposes another flaw with this way of thinking: that the knowledge we have access to accounts for all factors that influence our world. In reality, the missing or hidden information may shape the future far more. If we put excess weight on the events our memories can access immediately, we are discounting the weight of the more complete data set history provides, arrogantly assuming we know it all.
If current events are perceived as negative, we can become fearful, unable to escape the here and now and mistakenly believing the negativity will last forever. When fear is part of the equation, it can turn illogical thoughts into irrational actions. We end up making poor choices, based on faulty and incomplete information. When we only worry about today, it is often our future we sacrifice. For big decisions, like those of a financial nature, we must consider more than what has happened lately. It is time to use more brainpower.
To avoid the ill-effects of recency bias, start by slowing down to pursue deeper levels of analysis. Gather information before taking any consequential actions. Seeing that this is part of a much larger history can put things in perspective and calm us down before we make a mistake.
It is said that history doesn’t repeat, but it does rhyme. If we take a broader view of the past, we will see times that played out in a similar way to our current situation. History is not a precise indicator of the future, but a good teacher to remind us that uncertainty is constant and anything – good or bad — won’t last forever, despite what our recency bias would have us believe.
When it comes to investment decisions, remind yourself that your plans for the future are more meaningful than the urgency of today. Ask yourself if any changes you want to make serve the ultimate goal. Proper investing requires extreme patience, not quick action, so be ready to slow down and weather some storms along the way.
And, by the way, we did make it to the park that day, and the weather was beautiful.
