What is Recency Bias?
Recency bias causes people to assume that recent trends will continue indefinitely. After the S&P 500 returned 26% in 2023 and 25% in 2024, recency bias leads investors to expect similar returns going forward, even though the long-term average is closer to 10%. Conversely, after the 2008 crash, many investors stayed out of stocks for years, missing the 400%+ recovery from 2009 to 2020. The brain naturally extrapolates from the most vivid and recent experiences.
How Recency Bias Destroys Returns
Dalbar's annual study consistently shows that the average equity fund investor earns 3-4% less per year than the funds they invest in. A major driver is recency bias - investors pour money into funds after strong performance and withdraw after poor performance, systematically buying high and selling low. After technology stocks surged in the late 1990s, record inflows hit tech funds in early 2000, just before the sector lost 78%. The pattern repeated with real estate in 2006-2007 and cryptocurrency in late 2021.
Key Considerations
Combat recency bias by establishing an investment policy statement that defines your target allocation before emotions take over. Automatic rebalancing forces you to sell recent winners and buy recent losers - the opposite of what recency bias urges. Historical data shows that the best-performing asset class over the past 3 years is rarely the best performer over the next 3 years. Mean reversion is a powerful force in financial markets, and recency bias blinds investors to it.