The effects of recency bias on investing.
Biases are the filters through which we make decisions about everything—from what movies we watch, to what we have for lunch, to what we do with our money. All thoughts are filtered this way. In fact, it's impossible to make a purely unbiased decision.
What is recency bias?
Recency bias is the tendency to place too much emphasis on experiences that are freshest in your memory—even if they're not the most relevant or reliable. Recency bias can lead you to deviate from your carefully laid investment plans and make irrational decisions, like following hot investment trends, which may have damaging long-term consequences.
Recency bias can lead you to deviate from your carefully laid investment plans, which may have damaging long-term consequences.
The problem: The recent past is a poor indicator of the future.
Trendy, short-term market moves can potentially sap long-term results, making it more difficult for people affected by recency bias to reach their financial goals.
In 2022, after a decade of low inflation, many investors were shocked when the inflation rate rose to 6.4%.2 Recent experience may have caused them to discount historical examples of high inflation.
In 2021, real estate was one of the best performing sectors in the S&P 500 Index, delivering an annual return of 46%. But if you had chased that trend, you may have been disappointed when the sector returned -26% the next year.3
Keep biases in check by working with a Schwab investment professional.
A Schwab investment professional can be a sounding board for your investing goals and decisions, working with you to overcome any emotional or cognitive biases you may have. We can work with you on your terms, whether it's building a one-time plan, providing ongoing support, or introducing you to new products and solutions.
4 ways to remedy recency bias.
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Stay clear of financial and social media.
Constantly monitoring the market is stressful. It also increases the likelihood of making costly short-term mistakes or taking too little risk, since the chance of short-term loss is higher than the probability of loss over the long term.
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Look at the long-term.
Long-term investors are more open to suitable risk levels because they aren't concerned with short-term fluctuations. Your best bet is to create an asset allocation that meets your long-term goals and stick to it with regular rebalancing.
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Focus on executing for your future.
Some investors struggle to imagine their future selves, which makes them prone to pursuing short-term gratification. To make things more tangible, create a detailed vision and write it down. Consider where you'll live, the trips you'll take, and the causes you'll support. Then itemize these expected expenses as part of your long-term planning.
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Practice defensive behavioral finance.
Have an open dialogue with an investment professional to make sure you're making sound decisions that fit your long-term goals.
- Do you understand what role each holding plays in your portfolio?
- Are you holding on to investments for too long?
- Have a structure in place so you understand why, when, and how your portfolio is evolving.
Stay clear of financial and social media.
Constantly monitoring the market is stressful. It also increases the likelihood of making costly short-term mistakes or taking too little risk, since the chance of short-term loss is higher than the probability of loss over the long term.
Look at the long-term.
Long-term investors are more open to suitable risk levels because they aren't concerned with short-term fluctuations. Your best bet is to create an asset allocation that meets your long-term goals and stick to it with regular rebalancing.
Focus on executing for your future.
Some investors struggle to imagine their future selves, which makes them prone to pursuing short-term gratification. To make things more tangible, create a detailed vision and write it down. Consider where you'll live, the trips you'll take, and the causes you'll support. Then itemize these expected expenses as part of your long-term planning.
Practice defensive behavioral finance.
Have an open dialogue with an investment professional to make sure you're making sound decisions that fit your long-term goals.
- Do you understand what role each holding plays in your portfolio?
- Are you holding on to investments for too long?
- Have a structure in place so you understand why, when, and how your portfolio is evolving.
Put your new insights into action with either managed or self-directed solutions.
Learn even more on our behavioral finance podcast.
Choiceology®
Wharton professor Katy Milkman shares true stories involving high-stakes moments and explores the latest research to help you make better judgments and avoid costly mistakes.
