The theme this week on the Retirement Quick Tips Podcast is: 5 Behaviors of Emotional Investors That Lead To Ruin
Today, I’m talking about how to avoid the most destructive behavioral finance problem among investors: recency bias.
According to a white paper on this topic from Charles Schwab: “Recency bias is the tendency to place too much emphasis on experiences that are freshest in your memory—even if they are not the most relevant or reliable. Would you want to go for a long ocean swim after watching Jaws? Probably not, even though the actual risk of being attacked by a shark is infinitesimally small.”
I wonder if Hawaii tourism drops substantially after Shark Week on the Discovery channel?
So why is recency bias so destructive?
- It’s largely responsible for why investors buy high and sell low…when the stock market is at the top, you can’t find a worried investor anywhere. Everybody is buying. When the stock market has bottomed out, everyone feels hopeless and many have thrown in the towel.
- Recency bias leads us to just look at what’s happening today to make decisions that will impact you for the next several decades. If you think I’m exaggerating here, think again.
- According to JP Morgan Asset Management, the average investor only made a 2.9% annual return over the last 20 years - only slightly better than inflation, compared to the S&P 500, which made 7.5% per year. Why? Recency bias. Investors let the current trends and what they’re seeing in the news drive them to buy at the top and sell at the bottom, and their dismal returns are proof of that.
So what can you do to prevent recency bias from influencing your decisions? Actually you can do a lot of things. The best advice I can give here is not to act when you’re feeling scared, fearful, or worried that this time is different. It’s probably not, so wait a week…
That’s it for today. Thanks for listening! My name is Ashley Micciche and this is the Retirement Quick Tips podcast.
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Tags: retirement, investing, money, finance, financial planning, retirement planning, saving money, personal finance