Investtruth: What is "recency bias*"?
Let's say you move to a Rocky Mountain location with an average annual snowfall of 55 inches. You invest $70K in a luxury 4-wheel drive vehicle.
That first winter closes out with the lowest snowfall in a couple decades of just 12 inches. You're thinking, "That wasn't the best $70K I ever spent!"
You bought the car for many future winters, not just 2011-12 - still you are heavily influenced by what has recently played out in front of you. You were looking forward to not getting stuck in all that snow with your fancy toy! :) With all the local news coverage of the "snow drought" - you might even be tempted to believe that the recent event of less snow is the "new normal".
The low 12 inch snowfall seems "extreme" but it turns out that a low snowfall of 12-15 inches occurs once every 7-8 years. And so does 60-85 inches! So actually it's not that unusual - it varies a lot. The media will sensationalize the event further deepening your "recency bias".
That's recency bias. You're dealing with a long term issue but allowing short term happenings to bias you. It's part of being human. It's natural. Us humans naturally focus on the "here and now", not the long term.
We see that all the time in our world. Investors would like every asset class to rise in a measured way. It never happens like that. Either it plummets or sky rockets - THAT'S NORMAL! Our job is to help our clients minimize their reaction to recency bias. Stick to the strategy and don't let fear-mongers on TV, or irrational exuberance cause you to stray from the long term strategy.
Like snowfall, over time, the average returns of asset classes converge to their historical averages. Volatility is not unusual - it's expected!
* Credit to Carl Richards of The Behavior Gap for the term "recency bias".
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What to Do Next
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