Everything You Need To Know About Recency Bias
We have all tried to butter up our parents; days before asking for permission to go out to party, haven’t we? Hoping that based on your recent behavior, they’d grant you the permission? Even our parents tend to grant us permissions based on our latest behavior. It is natural for people to focus more on the recent trends and information while forming an opinion and completely ignore the past information since it is so fresh in the mind.
What is Recency Bias?
Recency bias is the tendency of a person to be more biased towards recent events while making a decision and totally ignore the past events related to it. People are incredibly likely to focus on the most recent information about a situation, person or company, rather than remembering and focusing on the past information. Recency bias is a cognitive bias that acts a roadblock to rational thinking.
For example, when the employee’s performance evaluation is round the corner, the employee portrays himself as a very diligent worker and shows himself as a model employee for his employer’s benefit. He will also try to flatter the employer and create a rapport with him in order to please him. During the time of the evaluation, the employer will favour the said employee as well, as the recent events are fresh in his memory. The employer won’t judge him based on his performance over the year and only focus on the recent encounters. Here, a well-deserving candidate who worked hard throughout the year might fail to get the appraisal, and the less deserving one might get a handsome appraisal.
Recency Bias and Finance
Recency bias is a concept in behavioral finance, which says that the investors are prone to give more importance to the short-term performance of a company rather than concentrating on the long-term performance. In case of an investment, recency bias is the biggest plague that could cloud an investor’s mind. Recency bias clouds one’s judgment and is harmful to our financial interests in the longer run.
For example, an investor gets a profit of Rs 50,000 on his investment of Rs 1,00,000 in the first three months of the investment. In the last three months, the value of his investment falls to Rs 90,000. Here, the investor may deem this investment as a failure based on the most recent loss of Rs 10,000 rather than focusing on the overall profit of Rs 40,000 that he made. This is a case of recency bias.
How to Overcome Recency Bias?
Recency bias, although small, can prove to be of huge impact on one’s investment decisions. These biases can have an adverse effect on one’s investment. Here are some ways to overcome recency bias:
- Make a proper plan according to your financial goals: First, step is to understand what you want out of the investments and then invest. You need to create a financial plan that meets your short-term, medium-term, and long-term goals. You need to stick to these investments accordingly and not get swayed by the recent events in the market.
- Don’t get swayed by the recent changes in the market: As an investor, you need to make sure that you keep a neutral approach and shouldn’t get affected by the current numbers. It is silly to base all your expectations on one high number.
- Consult professionals: In case of doubts about an investment during a very volatile market, it is advisable to consult a financial expert. He or she will guide you as to how you should proceed and what direction you should go in.
- Maintain a vast portfolio: It is not advisable to put all your savings and hopes in one company. It is smarter to have a good portfolio so that one investment can mitigate the losses of another investment.
Recency bias is the devil’s spawn in an investor’s life. It is important not to get swayed by the most recent numbers and changes in the market and maintain a neutral mindset while investing in any company. Current events can create an illusion in the investor’s mind; it is crucial to weigh in and look at all the aspects of an investment and not succumb to this bias.
This blog is purely for educational purpose and not to be treated as an personal advice. Mutual fund investments are subject to market risks, Read all scheme related documents carefully.