What’s one way so many retail investors sabotage their savings plans? Recency bias. It’s that ugly state of mind where views are most heavily influenced by what we have experienced most recently. It impedes our ability to see the big picture.

We lie to ourselves if we think we’re immune. “How did my investments perform last year?” is all too common a question.

Recency bias lulls us into false states of euphoria or panic. For example the S&P 500 provided a ROR of 28.6%/yr from 1995 to 1999 (compared to the 10.5%/yr ROR from 1970 to 2014.) Investors thought the proverbial trees would grow to the sky. Money flows show investors poured money into stocks during this period.

The result? Unrealistically high expectations. Building on the 1995-1999 ROR of 28.6%/yr investors couldn’t fathom the -0.58%/yr ROR from 1998 to 2002. They complained markets were rigged or found some other bromide and sold their stocks. How many thought, “I’ll never let that happen to me again.”? Conversely these unrealistically low expectations caused many to hold cash and miss out on the almost 13%/yr ROR from 2003 to 2007.

Recency bias!

The great irony of George Santayana’s “Those who cannot remember the past are condemned to repeat it” is that investors remembered the past all too well. At some point (probably when the ‘all clear’ bell was rung – someone does that, right?) investors noticed recent market performance and piled back into stocks only to suffer losses again in 2008. How many bailed out near the March 2009 lows and missed the 17.2%/yr ROR of the S&P 500 from 2009 to 2014?

Recency bias!

In short recency bias puts too much emphasis on the short-term. It’s the precise opposite of the buy low / sell high strategy.

What’s an investor to do? Here’s some food for thought to deal with recent market volatility:

  • Portfolios are constructed to match risk tolerance and ROR requirements determined by a financial security analysis. Ignoring these factors and, instead, looking at portfolio performance relative to an arbitrary benchmark is distracting and pointless.
  • A rules-based systematic approach is preferential to any other option in implementing a financial plan. As such the plan should be reviewed – not investment performance.
  • A diversified portfolio will never compete with the asset class du jour.