15
Information Processing Bias #7: Recency Bias
The present is never our goal; the past and present are our means, the future alone is our goal.
—Blaise Pascal (1623–1662), French mathematician and philosopher
Bias Description
Bias Name: Recency Bias
Bias Type: Cognitive
Subtype: Information processing
General Description
Recency bias is a cognitive predisposition that causes people to more prominently recall and emphasize recent events and observations than those that occurred in the near or distant past. Suppose, for example, that a cruise passenger peering off the observation deck of a ship spots precisely equal numbers of green boats and blue boats over the duration of the trip. However, if the green boats pass by more frequently toward the end of the cruise, with the passing of blue boats dispersed evenly or concentrated toward the beginning, then recency bias would influence the passenger to recall, following the cruise, that more green than blue boats sailed by.
Example of Recency Bias
One of the most obvious and most pernicious manifestations of recency bias among investors pertains to their misuse of investment performance records for mutual funds and other types of funds. Investors track managers who produce temporary outsized returns during a one-, two-, or three-year period and then make investment decisions based only on such recent experiences. These investors do not pay heed to the cyclical nature of asset class returns, and so, for them, funds that have performed spectacularly in the very recent past appear unduly attractive. To counteract the effects of this bias, many practitioners wisely use what has become known as the “periodic table of investment returns,” an adaptation of scientists' periodic table of chemical elements.
As the periodic table of investment returns in Table 15.1 demonstrates, asset class returns are highly variable. Many investors fail to heed the advice offered by the chart—namely, that it is nearly impossible to accurately predict which asset class will be the best performer from one year to the next. Thus, diversification is prudent (note how the diversified portfolio consistently appears near the center of each column). Investors would be wise to use this chart when establishing asset allocations.
Implications for Investors
Recency bias ran rampant during the bull market period between 2004 and 2007. Many investors implicitly presumed, as they have during other cyclical peaks, that the market would continue its enormous gains forever. They all but forgot the fact that bear markets can and do occur. Investors who based decisions on their own subjective short-term memories, hoped that near-term history would continue to repeat itself. Intuitively, they insisted that evidence gathered from recent experience narrowed the range of potential outcomes and thus enabled them to project future returns. All too often, this behavior creates misguided confidence and becomes a catalyst for error.
Table 15.1 Sample of a Periodic Table of Investment Returns
Source: Sunpointe Investments
| Highest | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | YTD | Q320 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| REITS 35.06% | MSCI EME 39.78% | Barclays Agg 5.24% | MSCI EME 79.02% | REITS 27.96% | REITS 8.28% | REITS 19.70% | Russell 2000 38.82% | REITS 28.03% | REITS 2.83% | Russell 2000 21.31% | MSCI EME 37.75% | Barclays Agg 0.01% | S&P 500 31.49% | Barclays Agg 6.79% | MSCI EME 9.70% | |
| MSCI EME 32.58% | EM Debt 18.11% | EM Debt –5.22% | High Yield 58.21% | Russell 2000 26.85% | Barclays Agg 7.84% | MSCI EME 18.63% | Russell 3000 33.55% | S&P 500 13.69% | S&P 500 1.38% | High Yield 17.13% | MSCI EAFE 25.62% | High Yield –2.08% | Russell 3000 31.02% | S&P 500 5.57% | Russell 3000 9.21% | |
| MSCI EAFE 26.86% | Blmbrg Cmdty 16.23% | AA Portfolio –23.17% | MSCI EAFE 32.46% | MSCI EME 19.20% | High Yield 4.98% | MSCI EAFE 17.90% | S&P 500 32.39% | Russell 3000 12.56% | Barclays Agg 0.55% | Russell 3000 12.74% | S&P 500 21.83% | REITS –4.04% | REITS 28.66% | Russell 3000 5.41% | Blmbrg Cmdty 9.07% | |
| Russell 2000 18.37% | MSCI EAFE 11.63% | High Yield –26.15% | Russell 3000 28.34% | Russell 3000 16.93% | S&P 500 2.11% | EM Debt 16.76% | MSCI EAFE 23.29% | Barclays Agg 5.97% | Russell 3000 0.48% | S&P 500 11.96% | Russell 3000 21.13% | S&P 500 –4.38% | Russell 2000 25.52% | Equity Hedge 2.24% | S&P 500 8.93% | |
| S&P 500 15.79% | Equity Hedge 10.48% | Equity Hedge –26.65% | REITS 27.99% | Blmbrg Cmdty 16.83% | Russell 3000 1.03% | Russell 3000 16.42% | Equity Hedge 14.28% | AA Portfolio 5.64% | MSCI EAFE –0.39% | Blmbrg Cmdty 11.77% | AA Portfolio 15.22% | Russell 3000 –5.24% | MSCI EAFE 22.66% | High Yield 0.62% | Equity Hedge 5.78% | |
| Russell 3000 15.72% | AA Portfolio 8.01% | Russell 2000 –33.79% | Russell 2000 27.17% | EM Debt 15.68% | AA Portfolio –0.76% | Russell 2000 16.35% | AA Portfolio 14.19% | Russell 2000 4.89% | Equity Hedge –0.96% | MSCI EME 11.60% | EM Debt 15.2% | AA Portfolio –5.85% | AA Portfolio 19.36% | AA Portfolio 0.59% | Russell 2000 4.93% | |
| AA Portfolio 15.61% | Barclays Agg 6.97% | Blmbrg Cmdty –35.65% | S&P 500 26.46% | High Yield 15.12% | EM Debt –1.75% | S&P 500 16.00% | High Yield 7.44% | High Yield 2.45% | AA Portfolio –1.43% | EM Debt 9.94% | Russell 2000 14.65% | EM Debt –6.21% | MSCI EME 18.90% | MSCI EME –0.91% | MSCI EAFE 4.88% | |
| EM Debt 15.22% | S&P 500 5.49% | S&P 500 –37.00% | Equity Hedge 24.57% | S&P 500 15.06% | Russell 2000 –4.18% | High Yield 15.81% | REITS 2.86% | Equity Hedge 1.81% | Russell 2000 –4.41% | REITS 8.63% | Equity Hedge 13.29% | Equity Hedge –7.13% | High Yield 14.32% | EM Debt –6.32% | High Yield 4.60% | |
| High Yield 11.85% | Russell 3000 5.14% | Russell 3000 –37.31% | AA Portfolio 23.56% | AA Portfolio 12.96% | Equity Hedge –8.38% | AA Portfolio 12.28% | Barclays Agg –2.02% | MSCI EME –1.82% | High Yield –4.47% | AA Portfolio 7.51% | REITS 8.67% | Russell 2000 –11.01% | Equity Hedge 13.69% | MSCI EAFE –6.73% | AA Portfolio 4.40% | |
| Equity Hedge 11.71% | High Yield 1.87% | REITS –37.73% | EM Debt 21.98% | Equity Hedge 10.45% | MSCI EAFE –11.73% | Equity Hedge 7.41% | MSCI EME –2.27% | MSCI EAFE –4.48% | MSCI EME –14.60% | Equity Hedge 5.47% | High Yield 7.50% | Blmbrg Cmdty –11.25% | EM Debt –13.47% | Russell 2000 –8.69% | REITS 1.42% | |
| Barclays Agg 4.33% | Russell 2000 –1.57% | MSCI EAFE –43.06% | Blmbrg Cmdty 18.91% | MSCI EAFE 8.21% | Blmbrg Cmdty –13.32% | Barclays Agg 4.22% | EM Debt –8.98% | EM Debt –5.72% | EM Debt –14.92% | Barclays Agg 2.65% | Barclays Agg 3.54% | MSCI EAFE –13.36% | Barclays Agg 8.72% | REITS –13.71% | Barclays Agg 0.62% | |
| Lowest | Blmbrg Cmdty 2.07% | REITS –15.69% | MSCI EME –53.18 | Barclays Agg 5.93% | Barclays Agg 6.54% | MSCI EME –18.17% | Blmbrg Cmdty –1.06% | Blmbrg Cmdty –9.52% | Blmbrg Cmdty –17.01% | Blmbrg Cmdty –24.66% | MSCI EAFE 1.51% | Blmbrg Cmdty 1.70% | MSCI EME –14.25% | Blmbrg Cmdty 7.69% | Blmbrg Cmdty –12.08% | EM Debt 0.61% |
When studying the market, good investors analyze large data samples to determine probabilities. By doing so, solid conclusions can be scientifically obtained. Recency bias causes investors to place too much emphasis on data recently gathered, rather than examining entire, relevant bodies of information, which often span much more extensive intervals of time. Investors need to be advised to look at underlying value and not just recent performance. If prices have just risen strongly, for example, then assets may be approaching or may have exceeded their fair value. This should imply that there are, perhaps, better investment opportunities elsewhere. Box 15.1 summarizes investment mistakes that can stem from recency bias.
Am I Subject to Recency Bias?
These questions are designed to detect cognitive errors stemming from recency bias. To complete the test, select the answer choice that best characterizes your response to each item.
Recency Bias Test
Note that this test requires that someone other than the respondent administer the test (i.e., it contains free recall memory exercises, etc.).
Question 1: Suppose you are asked to select a mutual fund for your portfolio based only on the fund's performance record. What is your most likely course of action?
- I will look at the one to three-year record of the fund to see how the fund has done recently.
- I will look at the five-year track record of the fund, as this time period showcases some elements of recent performance, but also historical performance.
- I will look at the 10-year track record, even though it doesn't focus on the fund's most recent performance.
Question 2: Read the following list of names to the respondent. Then ask: Did the list contain more male or female names?
- Sally
- Mark
- Amy
- Annette
- Jim
- Barbara
- Steven
- David
- Michael
- Donna
Test Results Analysis
Question 1: People who select response “a” or “b” are likely subject to recency bias.
Question 2: This list actually contains an equal number of male and female names. The male names, however, are concentrated toward the end of the list. Therefore, people who suffer from recency bias are more likely to recall that the list was dominated by male names.
Investment Advice
Box 15.1 listed some errors that investors often commit when they are subject to recency bias. These corresponding strategies can be employed by investors who want to moderate recency bias.
Sample size and extrapolating trends. Investors afflicted with recency bias often make projections based only on recent data—based on a data sample too narrowly drawn to be accurately informative with regard to future market trends. This behavior is relatively easy to overcome, as investors can often be persuaded by data when it is presented to them. Often, investors simply don't have immediate access to the data they need in order to make good decisions; other times, they lack the patience for undertaking a careful analysis. Education is critical to overcoming this aspect of recency bias.
Price versus value. Human nature is to chase “hot money,” and investors subject to recency bias often fixate on price performance while neglecting value indicators. Advisors need to demonstrate that out-of-favor, undervalued asset classes can make for very wise investments. The periodic table of investment returns is often a very persuasive visual aid and can help sway the recency-biased investor toward a balanced allocation.
“It's different this time.” Investors sometimes utter the words “it's different this time.” This is a phrase that should be taken with a grain of salt. Investment cycles often repeat. Rarely is it “different this time.” Stay invested and don't let your emotions get in the way of sound decision making.
Unbalanced portfolio. Proper asset allocation and diversification are crucial to long-term investment success. Investors should not let themselves become enamored with one certain stock and let that stock dominate a portfolio. The stock could tumble, and you could lose money. Education is critical to demonstrating why recency bias can be so dangerous. It might, perhaps, go without saying that, in these situations, nothing can replace the benefit of objective advice.