Investors’ Behavioral Biases: Part I – Recency Bias
Investor behaviour often departs from a logical, reasoned view. This is because people are influenced by their emotions, by errors and by their own personality. Understanding and correcting these behavioural biases is critical to improving investment performance.
Behavioural biases are commonly considered to be of two types: cognitive and emotional. However, in my opinion they overlap to such an extent that the distinction between the two is unnecessary for my purposes. An example of a cognitive bias is placing more weight on opinions with which you agree, irrespective of the facts.
Humans display dozens of behavioural biases, most of which are not relevant to investing, However there are around a dozen biases that very much influence investment decision making.
I am starting this series with Recency Bias as it affects everyone, but can be very difficult to identify. Recency Bias is where investors primarily base their investment decisions on recent events. And, it is important to note, each investor will have their own interpretation of recent events.
As an example, various surveys of market analysts show that when the market is going up, most analysts predict that it will keep going up. Conversely, when the market is going down most say it will continue its downward course. This occurs because the analysts are, probably unwittingly, putting more weight on recent market moves than on those in the distance.
To help combat Recency Bias it is important to look at events over the longer term, say three to five years out, in addition to recent events. But do remember that you cannot predict the future even a few years out. It also pays to take a more measured, statistical approach to help counter the emotions of the now.
Finally, be very cautious in relying upon 24/7 financial news media. The media always finds a, mostly specious, explanation for even the most minor of events. And it focuses on the now, with little context to any broader narrative. This has the effect of intensifying Recency Bias. Financial television is probably the worst offender. Along with many investors I don’t watch it, perhaps you shouldn’t either.