Does recent history make a difference in financial investment? Stock market prognosticators carry a track record of projecting ongoing investment trends based solely on most recent stock activity. A rising stock in recent weeks is expected to continue its upward trajectory into the future since there seems to be no indication otherwise. This can be a dangerous assumption, one which investors refer to as Recency Bias.
The premise of Recency Bias is the belief that “what happened in the most recent past will continue to happen in the future.” (Forbes) Investors being influenced by exceptional short-term performance falsely assume short-term growth qualifies as an excellent long-term investment opportunity. Poor market interpretation can lead to even worse investment assumptions if the investment’s long-term track record is ignored.
The recency bias can extend beyond single stock investments to overall market conditions. For example, a bull market can lead investors to increase buying activity… until we remember that yes, bear markets do exist. The fluctuation in investor behavior driven by recency bias shouldn’t presume we have any ability to predict market changes; what it should presume is a long-term investment perspective that cautions us to account for both market increase and market loss as inevitable outcomes.
Financial investing is built on the principle of accruing wealth over a significant length of time, not short-term market shifts. If you’d like another perspective on recency bias, New York Times columnist Carl Richards wrote an excellent article on the influence of recency bias and preparing for tomorrow’s market. The most effective defense against recency bias is constructing a portfolio with long-term investing in mind. Evaluate and choose performers based on their 10-year history, not the past two to three years. The longer their record of success, the more likely the success with reward you in your quest for financial independence.