Has recency bias affected your investment decisions, now or in the past? The Schwab BeFi 2021 study found that recency bias is the most common behavior that advisors believe impacts clients’ decision-making. 78% of Millennials, 75% of the Silent Generation, 74% of Gen X, and 56% of Baby Boomers suffer from it.
But what is recency bias? Why does it matter? What can you do about it so it does not ruin your retirement? On May 20th, 2022, we hit bear market territory—a 20% drop from the S&P 500’s high. It has a lot of people concerned. But should it? In this episode of the Best in Wealth podcast, I cover what recency bias is and how to keep it from derailing your retirement.
Outline of This Episode
- [1:45] Being a Milwaukee Bucks fan
- [4:17] What is recency bias?
- [8:06] Two reasons why recency bias is a problem
- [10:57] The cost of chasing hot investment trends
- [12:22] How to combat recency bias
- [18:42] Takeaways from this episode
What is recency bias?
Recency bias is the tendency to place too much emphasis on experiences that are fresh in your mind—even if they are not relevant or reliable. It is when you make decisions based on recent events, expecting that those events will continue. Recency bias can lead to irrational decisions. But recency bias can be hard to avoid.
Have you watched Jaws? If you watched the movie last night, would you want to swim in the ocean today? The answer was a big “no” for me. But when I was in Florida over spring break, I swam in the ocean every day. The movie was not on my mind. But if I had just watched it the night before, chances are I would not go in the ocean either (even though the risk of being attacked by a shark is minuscule).
Two reasons why recency bias is a problem
In February and March of 2020—in less than two months—the S&P 500 dropped 19.9%. It hit bottom. But because the market bottomed out, it triggered new money into the stock market—over $1 trillion. I have started investing money that I have had on the sidelines because I know that now is a great time to invest. Why? Because the stock market is down and many people are fearful. Also, because in April and May of 2020, the S&P 500 shot up 18%.
If you sold out of the stock market in March 2020 and lost thousands of dollars, you probably watched the S&P 500 climb almost completely back to where it was. You likely felt burned by the stock market. Recency bias is what led you to deviate from your investment plans, which likely had damaging effects and long-term consequences on your retirement plan.
How to combat recency bias: focus on the long-term
My goal is to help my clients see a different perspective and focus on how markets move over time. A long-term focus is always in your best interest. You will always see short-term upticks and downticks. The reality is that the market averages a correction (a 10% drop from its high) at least once a year. A bear market happens a couple of times a decade.
During the rebalancing process, we illustrate which investments have fared well and those that have fared poorly. We invest in asset classes that are doing the worst but snap back the most. In 2020, we saw great success with this strategy in small value and real estate.
We continuously educate our clients to avoid impulse decisions. What else can you do to combat recency bias?
- Limit your daily news intake and avoid being frightened by flashy headlines
- Agree on an amount of time to wait before making investment decisions
- Focus on meeting goals rather than individual return figures
- Work with a financial advisor to create an investment policy statement
Remember, the market averages one down year every four years. Not all downturns lead to down years. In 2009, we saw a 27% downturn but the market ended the year up 28%.In 2010, we were down 16% and ended up 17%.
Listen to the whole episode for a solid reminder that recency bias is dangerous—but it can be avoided with the right mindset.
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The Best In Wealth Podcast is hosted by Scott Wellens. Scott Wellens is the principal at Fortress Planning Group. Fortress Planning Group is a registered investment advisory firm regulated by the Securities Act of Wisconsin in accordance and compliance with securities laws and regulations. Fortress Planning Group does not render or offer to render personalized investment or tax advice through the Best In Wealth Podcast. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.