Feeling Good About Stocks? Watch Out for Recency BiasPosted on — Leave a comment
It turns out, investors have short memories.
If you have assets invested in the stock market, you might be feeling okay right about now.
Indeed, the stock market has rebounded smartly off the March lows.
The S&P 500 is still down on the year, but only a 3% decline – versus the stomach-wrenching 35% decline we lived through in March.
Do you believe the worst of the Covid-19 inspired stock market declines are behind us?
It feels easy to believe that right?
In fact, the jury is still out on whether this is a simply a bear market rally.
Nonetheless, it is all too common for investors to assume what has happened recently will continue to happen in the future.
Psychologists call this “recency bias.” It refers to the phenomenon where an individual more easily remembers recent events, compared to something that occurred in the past.
Simply put, the recency bias makes it easier for you to remember the recovery off the March lows than the sickening sell-off that began in February.
Here’s the rub. Investors often mistakenly rely on recency bias to make investing decisions.
It might not be wise to become too complacent about the stock market right now. It may be recency bias trying to trick you up.
Recent data shows that a lot of investors dumped stocks in February and March, during the stock market crash, and went to cash.
Assets in money market funds surged to a record-high $4.6 trillion recently, according to data from Refinitiv Lipper dating back to 1992.
If you are sitting on cash right now and feeling optimistic about the stock market. Consider how you may re-allocate those funds.
Major investment firms remain bullish on gold and are now advising high net worth clients to consider allocations to gold as a replacement (or partial replacement) for their bond allocation, given the paltry yields offered on U.S. Treasury securities today.
Don’t fall prey to this psychological investment trap. Don’t project recent experiences (the swift stock recovery) onto the future.
Right now, it may feel like it is smart to move back into a heavy weighting to equities. But, for investors who aren’t properly diversified, their portfolios could suffer – perhaps even dramatically – if trends change quickly.
When investors think about trading psychology, fear and greed usually pop to mind. However, there are deeper psychological biases at work – like the recency bias – that may impact how we think and act without even realizing it.
The lesson? Be cautious after big wins in the stock market. This is a time to rely on objective allocation principles. Be aware just after a big recovery rally in stocks, you may be vulnerable to bad investment decisions.
Never before has it been more important to seek out objective, expert investment guidance. If you moved to cash in February and March, give us a call and we can talk through scenarios that could be appropriate for your long-term investing goals and risk tolerance levels.
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