When speaking with clients we often discuss the aspect of recency bias. It is an important consideration when exploring investing, saving and overall financial well-being.
So, what exactly is it? To answer, we will look at the world of sports. Our staff’s former titles include high school lacrosse coach, sportswriter and standout youth tennis sensation, so we naturally look to the world of sports for examples and ways to explain things.
Mercifully, for fans around these parts, the baseball regular season recently wrapped up. For the Tigers, expectations weren’t exactly sky-high entering the 2019 campaign, based on the recency bias of seeing of back-to-back 98-loss seasons and upper management blatantly telling fans the club was in the midst of a rebuild.
However, despite only scoring 26 total runs through their first 10 games, the Tigers managed to start the season 7-3. Social media posts, newspaper columnists and afternoon radio hosts began to wonder if this could be something special, maybe the Tigers could be a surprise contender. Closer Shane Greene was a perfect 7 for 7 in saves (we all know about Detroit’s past bullpen woes) and technically the team was on pace to win 113 games.
However, by April 26 the team now stumbled to 12-12, more reflective of the team’s youth and inexperience. For the final five months of the season, the ‘boys of summer’ managed to make it a miserable summer, only winning 35 more games to finish with a record of 47-114. Greene was dealt to the Atlanta Braves while other stars like Nick Castellanos were also traded to actual contenders as the club continues its excruciating rebuilding process.
For the second straight season, the Tigers will have the opportunity to pick No. 1 overall in the draft thanks to their ineptitude. The days of competing for a World Series title or even a division championship (the team won four straight from 2011-2014) seem so frustratingly far away.
So, does that feeling of hope back in April as the Tigers were actually winning. But that feeling of only tying your hopes/dreams/beliefs to what has most recently happened? That’s familiar. While many are blinded by their loyalties and fandom, recency bias is often at the root of most ire from fans.
We all have it. Recency bias is the very human tendency to only to remember the recent past and then make bold assertions that the extended future will represent our version of reality that is only rooted in what we can remember —most recently.
This up and down feeling, and our proclivity to apply the recent past to the future certainly applies in investing. Back in December, we heard from many clients and prospects as they lamented the course of the market. Both the Dow Jones and S&P 500 had their worst December performance since 1931 – in the middle of the Great Depression. This concerned many investors as December is usually a positive month with the Dow only falling during 25 Decembers since 1931. On average, the S&P usually has a 1.6 gain in December, making it the best month for the market.
On December 21, 2018 the Dow sat at 22,445.37 while the S&P was 2,416.62. These were significant falls from where they both were on January 5, 2018 at 25,295.87 and 2,743.15 respectively. All of the gains from what had looked like a strong year were wiped away and then some in its final month. On September 21, 2018 the Dow reached a then-record 26,743.50. One year later, on September 20, 2019, despite many ebbs and flows of the market, the Dow read at 26,935.07.
Perspective in this instance is key. As of today’s writing (October 9), the Dow currently sits at 26,371.09 and the S&P is 2,920.74. Going back to the month of January, on January 6, 2017 the Dow was 19,963.80 and S&P read 2,276.98. January 8, 2016 saw 16,346.45 and 1,922.03. Go back a decade, in January 2009 the Dow as 8,599.18 and the S&P was 890.33.
To put it into a sports analogy, that’s par for the course. The press may report the constant highs and lows on it to generate clicks and coverage, but it truly is ‘part of the game.’
Let’s also look even a little farther back for some more perspective — it’s been 10 years since the financial crisis. With unemployment hovering around 10% and the Dow precariously positioned at 6,000. The talk was decidedly NOT about what a once in a lifetime opportunity is was to buy stocks! Soon after it got worse locally as Chrysler declared bankruptcy on May 1, 2009. On June 1st, General Motors followed suit.
Yes, things were bad. But eventually we saw a rebound. Look at where we are at now! But could we now be victims of forgetting the past, and only remembering the most recent past. (e.g., our last win!) For example, before the most recent turbulence, there was talk of the Dow hitting 30,000 this year!
Going back to sports as a metaphor, if you’re a rabid football fan, you feel the worst thing you could do is ‘buy in’ to your team right before they lose a heartbreaker or have a dry spell.
For serious investors with serious money, reacting emotionally to the roller coaster of recent events, predicting the future based on those events and then making snap judgements on those hastily formulated conclusions is a downright recipe for disaster. We know this to be true because we track the results. Dalbar Inc. conducts a study each year that repeatedly proves investors trail the market significantly — mainly due to emotional and psychological reason.
When we take the recent past and decide entirely based on our team’s performance, to either book Super Bowl tickets (buy all in to the stock market) or swear off our team forever (sell everything) we are suffering from recency bias.
What’s the antidote for this? First off, relax, take a deep breath and pause. Emotions are the enemy of reason so taking a 24-hour break from reacting to acting is a good idea. From there, take a look at your portfolio and remember it should be diversified among many types of asset classes and investments.
Being diversified means that some aspect of it should always be working, regardless if the market is euphoric or despondent. Therefore, having both bonds and stocks with exposure to both the domestic and international markets in the latter ensures that every fall of the market in the overall scope does not hammer your portfolio. Bonds and conservative investments play a crucial role in dampening market losses (they also dampen market gains) so evaluate your tolerance for risk to determine what portion of your assets should be lower risk.
Remember, although prediction is the name of the game in the news media and in sports radio, it truly is a fool’s errand. The fact of the matter is this: the odds of the stock market being up or down on a given day is about the same as flipping a coin. And yet, the market has risen over the years.
What’s that telling us?
Simply that whether you’re a diehard fan who watches all 182 games or someone who still believes Justin Verlander pitches at Comerica Park, you need to stay the course. Yes, not each game is going to look rosy, but stick with the team (your portfolio) and you will be rewarded.
Don’t jump off the bandwagon — but don’t book your airline tickets for the championship either without talking to your financial planner. He or she will make sure you’re earning hardware by the end of it all.
Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes and does not guarantee against market loss or greater or more consistent returns
“The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.”
Securities offered through Securities America, Inc., Member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc. Mission Point Planning Group and Securities America are separate companies.