What is Recency Bias?
It is a psychological phenomenon where an individual gives greater importance to recent events as compared to what had happened before. It is a cognitive bias. It skews their ability to accurately evaluate economic cycles. An example of the same can be seen in managers evaluating the performance of his subordinate as per his or her performance in the last 3-4 months rather than the entire year. The recency bias can tell us a bit about how memory works and one can use this to maximize one’s memory by better understanding how and why this effect takes place.
Recency Bias in Investing
This cognitive bias is hard to avoid in investing. This phenomenon is common in investing as investors tend to give more importance to short term performance as opposed to long term performance. For instance, investors stay away from equities when the market has fallen sharply due to the recency bias that they have, where they should have a response to the contrary, in light of their financial interests. It can lead an investor into making irrational decisions, such as following a hot investment trend or selling securities during a market downturn.
Ways to avoid Recency Bias while investing
- One must understand the business cycles and the manner in which the market works. Identifying which part of the business cycle they are in, will help one make a better decision.
- One must invest according to clearly defined financial goals, their portfolio approach and asset allocation and not look at it from the perspective of immediate individual returns.
- One must consult a financial advisor while making decisions and not get carried away by personal prejudices, biases and judgements.
- One must also not have a myopic view and must instead focus on the bigger picture.
- One might consider limiting their daily news intake, or you might create a mutually agreed-upon waiting period before making investment decisions too.
