We just passed the five year anniversary of the 2008 Financial Crisis and I am seeing a lot of articles asking “what have we learned?” Reflecting on this question, one thing I have tried to warn people of is to avoid falling into a recency bias trap. Recency Bias is the tendency to remember events in the recent past more vividly and give these events or observations more weight than historical information.
The trap occurs as one abandons their long term strategy, their process, and their ability to make rational investment decisions because they are solely focusing on recent events and experience.
You may have fallen into the recency bias trap if you did things like:
- Moved your money out of stock market-based investments in 2009, only to start putting it back in over the last year or two.
- In the last 2 years you put money that you have designated as cash reserve into the stock market.
- You decided to move money into bonds and gold as the only ‘safe’ way to invest, but this year, you are moving into the stock market.
And you took these actions because you saw more articles and news reports telling you to do it than telling you not to do it. Making decisions based on the last article you read or your past year’s investment returns is never a good thing. It is likely that volatility will occur this fall due to budget fights in DC, Federal Reserve actions, and geopolitical turmoil, but success is rare for the person who focuses their investment actions on every news event or market movement.
To fight against recency bias, ask yourself questions like:
- Am I thinking of changing my investments because my personal financial goals changed or because someone is telling me things are different?
- Do I think I need to adjust my portfolio because I am considering a job change or because I have seen several articles recently on rising interest rates?
- Should I consider a shift in assets because our family dynamic has changed or because there is political fighting in Washington?
Don’t get me wrong, taking action is sometimes the best thing to do. There may be structural changes in your situation that merit considering change.
For example, due to new tax laws in 2013, you may be thinking about:
- Limiting the amount of income subject to the new 3.8% Medicare tax.
- Reviewing your estate plans due to estate tax exemption limits being set at $5.25m.
Or due to the passage of time you are thinking about:
- Your college funding strategy because your oldest child just entered high school year and college isn’t far behind.
- Whether you should take advantage of the catch up provision in your 401k because you’ve recently turned 50.
- The ideal age for you and your spouse to take your social security income since retirement is near.
History tells us that taking action only on the recent events is not the best course of action. Find a long term strategy, based on your personal goals and situation, and stick with it.