How to overcome recency bias

How do you overcome recency bias, one of the most common and costly mistakes investors make?

Recency bias is our tendency to look at the recent past and project it indefinitely into the future. When markets have been falling, we assume they will keep falling; when times are good, we assume the good times will roll on. Either way, it can lead to serious financial mistakes.

In this video, behavioural expert Carl Richards explains what recency bias is, how it distorts our thinking, and practical ways to guard against it. He describes how a recent run of bonuses or a market downturn can lead us to make decisions based on a very short view of the past, and why, in the age of Twitter, our sense of the "recent past" can shrink to just a few minutes.

You'll learn a simple but powerful technique for protecting your future self: recording your feelings during a market crash or correction, whether by writing them down or filming a short video, so that you can remind yourself later what a big downturn actually feels like. Carl Richards compares this to leaving a note to open "when markets are back at X," a way to counter our natural tendency to forget painful experiences and repeat old mistakes.

The takeaway, especially for younger investors: you will be investing for a very long time, so tune out short-term noise, extend your view of the past, and focus on the bigger picture. That is what really matters.

Chapters / Key points

• What recency bias is and why it trips up investors
• How projecting the recent past into the future leads to mistakes
• Why the "Twitter age" shrinks our sense of the recent past
• A practical technique: recording your feelings during a market crash
• The "open when back on the lifeboat" note to your future self
• Why we are wired to forget painful experiences
• Why younger investors should tune out noise and focus on the long term

Transcript

What is recency bias?

Robin Powell: 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.

Carl Richards: 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 just to extend your view of the recent past, and right now, with sort of the "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."

Robin Powell: 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.

Carl Richards: 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 a lifeboat." So "Open when markets are back at X" can be incredibly valuable.

Robin Powell: 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.