Psychologie a chování
Recency Bias: Why We Overweight Recent Market Developments
Key takeaways
- Recency bias is the tendency to assign too much weight to recent events and underestimate long-term averages.
- After a prolonged rally, investors expect markets to rise forever; after a downturn, they fear another crash.
- Regular investing of a fixed amount (DCA) helps systematically overcome recency bias.
- Long-term data is a better guide than the performance of the past year or two.
Recency bias is a cognitive distortion in which we assign too much weight to recent events and underestimate long-term averages and historical context. In markets it manifests in two typical ways: exaggerated optimism after a bull market and exaggerated pessimism after a downturn.
How recency bias affects decisions
After three years of strong equity market gains, an investor is absolutely convinced the trend will continue. They buy in at the peak because "things are obviously going up." Then, following a sudden 25% drop, they conclude that markets are "broken" and sell everything — just before the recovery. Both moves are driven by recent experience rather than objective analysis.
Why the brain does this
The evolutionary logic is simple: what happened most recently is the most relevant for survival in the immediate future. On the stock exchange, however, this does not hold. Markets are mean-reverting — above-average returns revert to the mean over time, and the same applies to losses. Ignoring this mechanism is recency bias in action.
How to overcome recency bias
- DCA — investing a fixed amount at regular intervals removes the temptation to time the market. Read more in the article on cost averaging.
- Follow 10-to-20-year average returns for indices, not just the performance of the past year.
- Set your investment plan in advance and stick to it regardless of the current market mood.
Recency bias and fund selection
The same mechanism operates when choosing funds: investors buy the funds that earned the most in the previous year. Research shows, however, that stellar performance in one year is a very poor predictor of the following year's performance. This is especially true for actively managed funds, where passive strategies win over the long term.
FAQ
What is recency bias?
The tendency to assign too much weight to recent events and ignore the long-term average. After significant growth an investor expects further growth; after a downturn they fear further decline — both reactions are exaggerated.
How does recency bias harm returns?
It pushes investors to buy after a rally (expensively) and sell after a downturn (cheaply). That is the opposite of what works. The average investor therefore falls short of the return achieved by the disciplined investor who holds an index.
How can I protect myself from recency bias?
The most effective protection is automated regular investing of a fixed amount (DCA) and a firm investment plan. Decisions are made in advance — not under the influence of the latest headlines or market moves.