What is Recency Bias?
Recency is a psychological term.
It implies an individual emphasises more on the recent events compared to the past.
While investing, it simply means an investor giving more importance to the recent happenings/news/events rather than considering the historic data and analysing the past.
For instance, if you are asked to name 50 cuisines you ate you are likely to name the most recent and favourite once and at the same time forget the ones which were more on the healthy side, which didn’t satisfy your tastebuds and the once which you ate 1 or 2 years back.
Wee, this psychological tendency is not just limited to foodies, in fact, Recency bias is seen in many aspects of a normal person’s life.
Consider a corporate scenario, for instance, statistics have been evident that for performance evaluations, evaluators tend to consider the recent 3 – 4 months of work done by their employees rather than considering the performance over the entire year.
There has been a similar pattern observed among cricket fans.
These fans often judge a bowler or batsman based on his performance in the last series or the last ODI / T20 championship and not considering their past cricket career.
Hence, Recency bias is not new in the investing arena.
Recency bias in investing
Recency bias is common among investors and very common among naïve investors.
They start considering short term performances over long-term performance which is not a trait of a successful investor in the long run.
For instance, an investor invests Rs 100,000 in a mutual fund.
Say in the 5th year of investing the market value of this investment grows to Rs 175,000.
And due to the unformidable market situation, this value further came down to Rs 150,000 in the last three months.
Here, the investor looks at his investment performance as a loss of Rs 25,000 in the last 3 months.
He completely looks over the fact that in the last 5 years his principal capital got appreciated and gained an overall profit of Rs 50,000.
This mind game is recency bias.
Seasoned investors say, in equity, the higher the risk higher is the reward, some argue that the ‘time’ constraint to gain profits is missing in the above statement.
But my dear fellow investors, the catch lies in the word ‘investors’ itself, as a person who invests for a longer time frame.
An investor has to be patient for his capital to grow.
And hence Investors choose to stay away from equities when the market dips drastically without understanding the fact that there could be a good opportunity to gain in the future.
Such drastic dipping markets serve as a great opportunity because one gets hold of quality stocks at a relatively cheaper price.
Recency bias is considered a bad trait amongst investors because it blurs judgments and clouds our financial interests in the long term.
How to get through Recency Bias
There is no ‘jumping’ phase, in investing, every investor has to go through this phase.
The one who supports it is never successful and the one who learns to tackle Recency bias enjoys good gains in his portfolio.
Here are some of the tips which might help you get through the phase:
– We know markets thrive in cycles. The market is either Bearish, Bullish or sideways. But at any point in time, the market follows either of the three cycles. It is just a matter of timer until one cycle ends and the other starts. So if you have decided to invest, invest and hang in there for at least 10 years.
– If you are investing, keep a fixed goal. Investors must understand and should be able to clearly define their financial goals. This helps the individual to set a time horizon and expect the next anticipated return. Sticking to a financial plan motivates the investor and answers the question of ‘why not exit early’. Goal based investing helps inculcate a sense of discipline and be patient while not getting affected by the violent volatile market.
– While reviewing a portfolio’s performance, a common mistake found among investors is that instead of focusing on the performance of your overall portfolio, they are tied to individual stocks and sometimes worse, in spite of holding for a long time period they tend to hold the portfolio short-term and exit the trades. Note that Asset allocation is one of the crucial factors in the performance of your portfolio which cannot in any condition be neglected. An investor must keep track of maintaining the asset allocation and checking the rebalancing necessity regularly to be at the best of the portfolio health.
– Seek professional aid whenever in doubt. Financial advisors can be of great help right from building your portfolio, analysing your risk appetite and investing in the most turbulent markets.
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– If you think all of these are causing unnecessary confusion, the simplest solution is to invest in Artificial Intelligence.
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Consider your portfolio as a Chariot and the funds in it as the horses and you the Charioteer.
The Charioteer is a person, who doesn’t just sit and command, he plays a vital role in directing the horses and most importantly following the trend.
You will have the knowledge of adjusting the speed of the Chariot and understand the fitness of your horses at any point in time to pull your Chariot.
If you have strong horses, you have a greater potential to speedily reach your goal.
There might be times when your star horse is no longer needed, and you might decide to let it go and buy a new horse.
There can be a number of reasons why your Chariot sometimes didn’t go well as expected.
A good Charioteer will always try to understand the reasons for such underperformance and lead the right way acting patiently keeping in mind the performance.
Stay focused on your goals and not on your portfolio.
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Until next time…