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What is 'recency' bias? [video]

And how does it affect investors?

    One of the big problems investors face is what behavioural psychologists call, recency bias

    In other words, looking at the recent past and projecting that indefinitely into the future...

    Behavioural expert Carl Richards, explains how investors can overcome recency bias...

    RP: One of the big problems investors face is what behavioural psychologists call recency bias. In other words, they look at the recent past and project that indefinitely into the future. Here’s behavioural expert Carl Richards.

    CR: So if the recent past has been something really negative, we project that indefinitely into the future. “If things continue like this, I’ll be broke by...” You know we project that. If that is really good then we can make some major mistakes that way too. “I have gotten a bonus every year in January. For the last three years, I’ve got a bonus and we are thinking about buying a new house. Well yeah, I think we can buy a little bit more expensive house because that bonus is just around the corner” and then you do not get the bonus. It sort of wreaks havoc and I think we are really good at doing it, I think it happens all the time like it is something we need to check. The only solution I know to that problem is to just to extend your view of recent past and right now with sort of “Twitter age”, recent past is often like three minutes. Could we just extend our view of the recent past and consider “Oh remember just five years ago that happened.”

    RP: One way you can guard against recency bias as an investor is to record your feelings after, say, a stock market crash or correction. You can write your feelings down.. or perhaps even record a video, to remind your future self of what a big market downturn feels like.

    CR: I sort of think of it as being on a lifeboat and we just want to record a video, like when I get back on the lifeboat I would really like to make these changes, “Hey Carl this is me telling you that if you are back on the lifeboat right now will you remember it was not fun.” Now I think this ability to forget negative experiences in the recent past has kept us alive as a species. No one would run a second marathon and I cannot comment too directly on it but I have been told by my wife that nobody would have a second child right? If you could remember the experience of having the first one because of the pain. We discount that really quickly. So just reminding ourselves of that pain when we are back on the lifeboat is important either by recording it or writing a note to yourself “Open when back on lifeboat.” So “Open when markets are back at X.” Can be incredibly valuable.

    RP: One more thing, especially for younger investors. You’re going to be investing for a very, very long time. So, try to tune out any short-term noise and focus on the bigger picture. That’s what really matters.

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