Have you ever heard of recency bias? This is where we base decisions on recent events and outcomes, as opposed to more trusted ways of making decisions, such as intuition, research or even considering many years of history. Quite often there is no rhyme or reason as to why recent events are particularly relevant in making decisions, but they are simply easier to consider as they are fresh in our minds.
This raises its head in many aspects of life, for example bookmakers make millions by people betting on “current form” only and ignoring more relevant factors and realistic expectations!
But it’s in the world of investing that we quite regularly see recency bias rearing its head, often with very damaging consequences. You only have to remember the thousands of people in Ireland who bought property in 2006 & 2007, as it was a “sure thing” and everyone had made money in the previous years. These people were blind to the dangerous market conditions and suffered greatly when the market collapsed.
Similarly other investors make their investment decisions based on how the market has been performing recently, rather than considering the fundamentals of a market. They forget that markets can go up and down, and instead assume that because markets have been going in one direction, they will keep going in that direction. As a result, they buy into markets that have risen (when they are expensive) and sell out of markets that have fallen (when they are cheap). We know from experience and we constantly remind our clients that past performance is not a guide to future performance.
We work hard with clients to avoid any recency bias in decision making. We hear clients saying “I haven’t been sick in years” as we propose income protection and specified illness cover. We can show you the risk if you base such a decision on “current form” only, and the impact this could have on your entire financial future. We can also show you the potential impact on your investments and pension funds if you only look backwards at past performance. We can do this by considering some “what if”scenarios based on unexpected market movements, irrespective of how unlikely they might seem at the time. We know that stock markets show no sympathy for any recency biases!
We can review how a continuing bull run will impact your financial plan. But we can also show how an unexpected dip in markets will also affect you. Considering both scenarios brings a greater level of realism to the investment assumptions that you might ultimately use.
Consider the past as one part of your research when making decisions about your finances. But careful consideration of the future is what will determine whether you achieve your financial goals or not.