Have you fallen for the recency bias when it comes to investing?
Hopefully not, but it’s likely that many of us have done so in form or another at different times. But first, you may ask, what exactly is the “recency bias”.
The recency bias is a psychological phenomenon that causes us to focus more on more recent events vs. those that occurred in the past. In terms of investing, it can cause us to pay an otherwise inordinate amount of attention to the most recent events impacting market prices, while ignoring historical trends. This can cause unintended consequences.
The reason I’m thinking of this concept now is the reality of how the stock market has performed in recent years, considering where it was and where it is now.
On March 9, 2009, the S&P 500 index closed at 676.53. This represented a continuation of a steep drop that saw significant paper wealth evaporate. The thing is, many people looked at this paper wealth as being “theirs”, and ended up feeling quite uneasy about continued losses. Thus, many folks ended up panicking and shifting their asset allocation to include less exposure to stocks and more exposure to “safer” alternatives. Even more drastic, some people bailed out altogether, seemingly thinking that the sky was falling.
Question for You: How were you feeling about stocks at the time? Did you change your investment strategy as a result, or at least consider it?
While many people have questions over the overall state of the economy, we should all be able to agree that the stock market has certainly recovered. On May 23, 2011 (most recent close) – 2 years and 2 months after being at 676.53 – the S&P 500 closed at 1317.37.
That’s a nearly 95% increase, in just over 2 years!
As I said, there are still questions on the economy, but I don’t hear nearly as much about people looking to flee the market out of fear of some kind of impending stock market doom.
Question for You: How do you feel about stocks today? How does your level of optimism/pessimism rate versus back in early 2009?
If we looked at historical trends, that sudden and swift drop a few years ago might have appeared to be a buying opportunity. Stocks weren’t going to go down to no value, but there were people that suffered so much anguish over seeing their portfolio values evaporate that they got out of the market to gain peace of mind. Unless they soon bought back in right after, they missed out on the great bull market of the last 2 years. Thus, they would have taken a huge net loss.
This, to me, is an example of why it’s important to temper our thoughts and emotions about stocks and other investments and consider the historical data for context. This way, we can react in a calm, rational way rather than making rash moves that hurt us in the long run.
Thankfully I didn’t do anything foolish during that time with existing investments, but I did give it some thought. Ultimately, I stayed in the market with no change – though future earnings were treated more conservatively with a higher percentage of new savings put in cash. This probably cost me some capital gains.
Of course, nobody can totally predict the future, so who knows what will happen. That being said, are you more optimistic about the market today than a few years ago? Are you more likely to invest in stocks now, with peace of mind and optimism, versus back then?
So again, no predictions here, but I’m just saying…..those 95% 2-year returns seem great, but how many times has this happened before?
Personally, I think the recency bias is a good concept to keep in mind, with value in many situations – stocks, real estate, interpersonal relations, sports, and many others.
How did you answer the questions above, and how (if at all) have you been impacted by the recency bias?