Breaking the Spell of the Latest: How Recency Bias Can Mislead Investors

Breaking the Spell of the Latest: How Recency Bias Can Mislead Investors

Have you ever invested on recent news from a company, only to realize your excitement had downplayed a bigger narrative? I have more times than I’d like to admit. Let’s take a closer look at the psychological bias called recency bias.

It’s tough since our brains are wired to prioritize recent events, especially when we try to predict future events.

Recency bias is a cognitive bias where our minds tend to give more weight to recent events than earlier ones. Causing investors to skew decisions in the direction of the most recent news or stock price movements, rather than considering the full range of available information.

An investor might sell a stock after a short dip, assuming it will continue down, without considering the company’s long-term potential. Or they might buy a stock that has been in the news and doing well, assuming it will continue, but downplay that the industry is challenged.

Conversely, if a stock has recently had a downturn, an investor with recency bias might assume that the stock is doomed, without considering whether the dip is a temporary blip or a sign of a systemic change.

Overcoming recency bias takes discipline and a perspective that matches your time horizon. Long-term investors should focus on a company’s fundamentals, such as financial health, growth potential, external trends, and management team, over short-term developments or price moves.

Investors should also avoid making decisions based on emotions and instead consider a well-thought-out investment strategy. This can include diversifying your portfolio, setting specific goals, and sticking to a set of rules or guidelines.

It’s important to keep up with your stocks, ignoring developments can be disastrous, but keep your recency bias in mind when you weigh your response to the day-to-day volatility. Is this just short-term noise or is there an overall shift that challenges your investment premise?

Tip: For long-term investors, write down your original investment justification and target price. Then hold new developments up against it. You may add to this reasoning, but seriously reconsider if you start changing your justification to fit underperforming investments.

Unfortunately, not all brokerages allow you to add notes to your positions, but many of the independent stock trackers, like StockHawk, do. Hope this will help you on your journey.