There’s nothing like a blizzard to drive up demand for snow tires. The inverse is also true: the longer it’s been since an event took place, the less likely we are to believe it will happen in the near future.
This effect is known as the recency bias, and it can innocuously sway our decision-making, especially when it comes to investing. Here are some points to keep in mind about how this bias can affect you, and how to steer clear of it in your strategy:
How recency bias occurs in investing
The effect where we tend to believe more recent results are indicative of the future rears its ugly head often in the stock market. For instance when the stock market just dropped, we might be led to think it’s certain to drop more in the future. On the opposite end of the spectrum, we might be led to think more short-term gains are on the horizon when the market goes up.
Often, this results in the very opposite of successful investing: you’re buying high, or selling low. Remember: good investing often feels lousy and involves contrarian thinking.
How to avoid recency bias in investing
A clearly laid out long-term strategy is the best defense against recency bias. For instance, you’re unlikely to make a concentrated bet on “surefire” rising stock market prices when you already have an asset allocation for retirement in place.
Utilizing an advisor to stick to your plan
Of course, sometimes sticking to a long-term investment strategy is easier said than done. So at LexION Capital, we serve as coaches to help guide our clients to the finish line with thoughtful strategies based on their risk tolerance. If you’d like to learn more, don’t hesitate to contact us today.