Recency Bias is pretty simple. Just think it this way “your short term memory dominates your long term memory” Usually it is the tendency that what happened in recent past will continue in the future.
Consider an example of flipping a coin. We all know that the probability of any of the two possible outcomes in a fair throw is exactly half (50%).
If we toss the coin 10 times, and all the outcomes have been tails, then Recency Bias makes you think that next outcome will be tail only.
Remembering the recent behaviour can be positive or negative. In many situations, this bias might just work fine, but when it comes to investing and money it will always cause trouble.
Recency Bias in Investing
In investing, recency bias happens when you end up choosing investments or if you over weight the short term happening while making investment decision, which means ending up selecting the best performing fund in last few months.
When market drops one can end up pulling their money out, as seeing the recent down trend you become convinced that it will never climb up because the recency bias tells you so, potentially leaving you worse off than if you would have stayed invested.Even if we know that past result don’t predict future performance, but it might make scene to analyze the investment avenue with giving equal weightage to long term, medium term & short term performance.
Thinking Man gives following lessons to avoid Recency Bias while investing:
- A proper financial plan will help you avoid this problem.
- Don’t only invest based on short term performance, also take long term performance into consideration.
- Identify your goals & make goal based investment.