Tags: Wealth Management, Investment Lesson, Mutual Funds, Stock market, Budget, Finance, Investing, Personal Finance, Investment
Article Summary
Recency bias is a behavioral bias that makes investors give recent events and conditions outsized importance in their decisions, often leading to harmful consequences.
This bias makes investors take harmful decisions in haste, based on incomplete information. More so during sharp market upturns, downturns, and periods of extreme volatility.
Best way to avoid this bias is have a minimum period for deliberation, also consider data and information from distant past, stay focussed on financial goals, periodically review their progress, and take quality professional advice.
“Look before you leap” is a well-known proverb that advises us to weigh the consequences of our actions. For many, this can appear as a truism in daily life. After all, whether it is crossing the road, or buying food, clothes and gadgets, people do try to take decisions after careful consideration. However, when it comes market-based investments which experience bouts of turbulence, investors often end up taking decisions based on immediate and recent conditions. Often such decisions cause substantial long term damages. Experts term bias of outsized importance accorded to immediate and recent conditions and events as Recency Bias.
What is Recency Bias?
This is a behavioral bias towards giving recent events and conditions outsized importance in investment decisions. Typically, during conditions such as sharp upturns and downturns in markets, besides periods of high volatility, investors get unsettled and act with the assumption that recent and current conditions will also prevail in the future. This is so because in such circumstances, investors find information about recent events easiest to recall which often leads them to irrational decisions. Unfortunately, decisions made based on incomplete information and inadequate analysis leads to erroneous and harmful decisions.
How Recency Bias Impacts Investor Behavior
Having understood Recency Bias meaning, we need to understand the implications of this bias on investors and their investment decisions with Recency Bias examples.
Recency Bias in booming markets
During sharp equity market upturns and market booms, investors tend to invest even more in equities. Consequently, their overall mix of investments gets skewed towards equities with investors ending up taking higher risk than they are normally comfortable with. During subsequent periods of market volatility or downturns, this often leads to their panic-driven exits, often at a loss. Impact of Recency Bias is often exacerbated by what is known as Fear of Missing Out (FOMO) where investors opt for certain currently popular investments, in the fear of missing out on these ‘growth opportunities’.
Recency Bias in market downturns and lows
Recency Bias can be equally harmful during market downturns. Investors mistakenly assume that markets will continue to be at a low or have subdued growth. This keeps them away from investing in equities and benefit from the typical long term growth in 8-10 years, or more. Consequently, they end up saving less for their major needs than they need to.
How to Deal with Recency Bias
Having understood Recency Bias meaning and Recency Bias examples, we need to identify steps to avoid its ill-effects. Here are some of them.
Create a waiting period before any action
Keep a minimum period available for analysis and deliberations on the current conditions so that you are adequately informed before taking any decisions and acting on it. Also, consciously avoid frequently checking the status of your investments during turbulent market conditions as this is likely to elicit a harmful knee-jerk reaction.
Consider information from the distant past
An effective way of countering Recency Bias is to bring into consideration information and facts from the distant past. For instance, when we are aware that markets have gone through periods of volatility in the past and still have provided handsome growth, we are likely to stay invested for the long term.
Evaluate performance during different periods
This is a logical extension of the previous point. Compare the performance with respect to the right benchmarks and comparable alternatives over different periods of time such as 1, 3 and 5 years.
Retain focus on financial goals
Your investments need to be earmarked for your financial goals. You need to periodically review their progress say, annually. Evaluate what impact the current conditions will have on your financial goal and what action, if at all, is required.
Periodically review asset allocation
By periodically reviewing the mix of investments across asset classes or asset allocation, you are better informed about whether your investments are progressing towards your financial goals. After a sharp run up in an asset class like equities, there could be a rebalance of investments to ensure that asset mix remains according to plan. Also, new investment opportunities can be tapped.
Take professional advice
Consultation with qualified financial advisors can help you assess the impact of current market conditions and determine whether it requires a response. If so, it helps determine the appropriate response.
To conclude, as with other behavioral biases that impact investments, for Recency Bias too, the key is to be aware of what is Recency Bias and take practical steps to avoid its adverse effects.
FAQs
Why is it important to be aware of Recency Bias?
Investor awareness about such biases help them have a modified decision making process that aids them in getting the best out of their investments.
How does Recency Bias affect financial future?
This bias makes investors deviate from financial plans for different financial goals, often causing irreversible damage, especially panic-driven premature exits made with losses.
Disclaimer:
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.
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