Recency Bias: Surviving the Winter
Do you think you could step outside right now without a jacket? Of course not! It’s been cold, windy & rainy for these past few months. (For those of us living in the Northeast.) Our minds and our bodies are telling us to layer up. It was cold today and it will most likely be cold tomorrow. We don’t have to check the weather to know that.
What we do know is that eventually spring will come and with it: warmth. Though spring is a few months away, it is starting to feel like we’re going to be stuck in the winter season forever.
While harmless & actually beneficial (as we don’t want to freeze to death), in the picture I have painted, this is an example of mental behavior known as Recency Bias.
Recency Bias is a behavioral pattern in which we tend to focus our attention more towards the latest and current information. Subconsciously, we are more inclined to listen to a voice in the back of our heads that asks, “What’s been going on lately?”
While it is perfectly fine to stay updated on what is going on in the world around us, such as the weather, in certain cases, it can warp our views.
When it comes to investment market conditions, for example, a large number of investors will focus on the momentum wave that is occurring at any point in time. Whether the short-term market trends are positive or negative, this bias goes hand-in-hand with an impulse that makes us want to take advantage of what has been going on in the past day, week, or month. Such momentum can feel like it will go on forever and we may miss out, but just like the winter, the season will change.
Acting on this can throw a wrench into our big picture plans. It is important to remember that there is a cost to acting on these thoughts. It could be a transaction cost, capital gains consequences or taking on unnecessary risk. The key takeaway is to remember that yesterday’s or today’s events are not the only reference point for our entire future.