It’s easy to think of finance, and financial planning as all about money. But a lot of how people deal with money is rooted in their background and feelings. When it comes to making decisions, about money or just about anything in life, our biases influence our decisions.
One form of bias that commonly clouds the clear thinking of an investor is called Recency Bias. It leads us to over-emphasize information we just received. The newer the information, the more our brain prioritizes its value. The problem with that is that there's no guarantee the latest information isn’t always the most accurate or comprehensive information.
Let’s unpack the four basics of Recency Bias so as an investor you can recognize it, and avoid allowing it to hijack the short-term priorities and long-term goals that are the foundation of solid financial planning.
1. How to know if you’re being biased by recent information?
You know you’re being influenced by Recency Bias if you feel pressure to act based on information you just received. If the news cycle is pounding a point about mortgage rates, stock behaviors, or retirement issues, and it pushes you to feel as if you have to do something now, you may be feeling the effects of bias. Know that new information, right, wrong, accurate, or exaggerated is parked front, center, and most readily available as your brain tries to make a decision.
2. When is Recency Bias most likely to pop into your head?
Recency Bias takes over for most people whenever market changes start making headlines. In a bear market as prices drop, the constant news about falling prices makes us feel like it's the new norm. That perceived plunge to the bottom of the bottom creates a strong urge in many people to sell their holdings in an effort to get out, when dumping shares at low prices may not be the best thing at all.
OK, so that’s how the negative news cycle can lead investors in the wrong way. But what about positive news? Recency Bias is just as dangerous when the news starts celebrating the return of a bull market. When the market is rising, lots of people tend to feel overconfident and act with the false confidence that it will never stop.
3. How Recency Bias hurts clear financial thinking.
Recency Bias can lead you to invest more confidently and aggressively when the market is on the way up and jump out too quickly as the market makes changes on the way down. In other words, the Recency Bias that is so easily parked and reinforced in the front of the brain overrides the time proven advice further back in your brain that says stay calm, carry on, and focus on buying during a low and selling at a high.
4. How to prevent over reacting to recent information.
If you want to reinforce Recency Bias, just keep watching the 24-hour news cycle. To avoid it you’re going to have to stop checking the market. Keep in mind that’s no easy task. Market changes are hot topics. It’s on the news, in your social feed, on your stockwatch app, even on the video screens on the treadmills at the gym.
The truth is that even the most scary and attention getting headlines about recessions, depressions, job loss or the tumbling of fan favorite individual stocks have little impact on long-term market trends.
Step one is to recognize that the urge to check back into the market repeatedly is actually a sign of Recency Bias in action.
Step two is to remember that Recency Bias points us in the wrong direction as investors. So fight it by remembering this one, time proven, unbiased fact: you build wealth if you buy low and sell high over time, it doesn’t work the other way around.
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