How to Avoid the Dangers of Recency Bias in Investing
There’s nothing like a blizzard to drive up demand for snow tires. The inverse is also true: the longer it’s been since an event took place, the less likely we are to believe it will happen in the near future.
In academic circles, this well-documented phenomenon is known as recency bias. Essentially, it’s the tendency to believe that what happened in the most recent past will continue to happen in the future, and it can trick us into making decisions we might not make otherwise.
This bias can be a particularly dangerous problem for investors, especially with today’s around-the-clock media environment. Recency bias helps fuel trends in the news by tricking your mind to pile into holdings that are doing well and cash out of investments that are doing poorly. The problem is, sooner or later trends reverse.
Before the dot-com bubble burst in 2000, for instance, rapidly appreciating stock prices convinced many investors that technology stocks where a surefire certainty going forward. Needless to say, those who made concentrated bets in this sector were sorely disappointed. Similarly, many others who sold off shares during the global recession of 2008–2009 sold at an extreme low and missed much of the market rally that followed.
The best defense against this bias and irrational decision-making based on trends is a long-term investment plan. When we look at the markets close up, we see a great deal of volatility. It is the wide-angle, panned back view that serves wise investors. With this perspective, it is possible to see that the long-term trend is positive. That upward trend is why investing wisely is such a powerful means of wealth creation. The difficult part is a matter of personal discipline: the ability to tune out market noise, stay the prudent course, and allow your wealth to grow over time.
At LexION Alpha, we attempt to ignore short-sighted perspectives and perceived hot streaks when it comes to investing. Instead, we attempt to take a data-driven and analytical approach to focus on long-term investment strategies for you.