Recency Bias & Decision Making

When faced with difficult decisions, our minds take shortcuts, especially during uncertainties and periods of volatility. Human minds tend to analyze situations and predict the future based on certain biases. Recency Bias is a cognitive bias where an individual overemphasizes and has a higher preference for recent events and experiences. Simply put, it tends to favor recent events more than earlier ones.

We are naturally wired to remember what happened most recently. Such events are the freshest in our memories. They may not be reliable or relevant, but they are easier to remember and discern than events in the distant past or unknown outcomes in the future. We often fall prey to recency bias because of our incapacity to predict the future objectively.

The bias manifests itself in various ways and is sometimes associated with other cognitive biases. A relatable example of recency bias occurs when a person is asked to list the ten best movies they have ever watched. A person is more likely to recall the movies they watched in the recent one to two years than movies they watched five to ten years back.

Recency bias is common and the most difficult cognitive bias to avoid when investing. It causes investors to become irrational in their decision-making process, resulting in unsound and risky investments. Recency bias impacts the investment decision-making process in a variety of ways, like preventing investors from accurately analyzing economic cycles in the market. An investor may refrain from buying because of a recent period of declining economic performance countrywide. They become pessimistic about market recovery following a recession. Further, an investor will hold on to an investment in a bull market and ignore that the cycle may not persist, disregarding the idea that stock markets experience ups and downs. Because of bias, investors miss the opportunity to buy at discounted rates and exit the market to book a profit.

Basing decisions on recent occurrences can get investors into deep trouble. Still, recency bias causes investors to employ this strategy. As a result, there has been a genuine concern among investors giving rise to a meaningful discussion on how to counteract this extreme cognitive bias.

Cognitive biases can lead to the deviation from a well-crafted plan, resulting in adverse and irreversible long-term consequences. The short-term moves caused by recency bias can gradually affect long-term outcomes, making it more difficult to achieve a previously declared goal.

Since recency bias comes from within, the best way to overcome it is by sticking to a plan and working with a professional. For instance, suppose you are an investor and unconsciously prefer recent trends when making important investment decisions. In this case, it is best to work with an independent and experienced financial advisor. They will help you have a broader view of the market, analyze past trends objectively, consider market forces, and evaluate risks comprehensively to help you make sound investment decisions.

Most of the time, we unknowingly fall victim to the harsh implications of cognitive bias. Therefore, acknowledging the bias is a necessary step toward making suitable and more effective decisions. Part of the process involves acquiring expertise to analyze opportunities objectively, and gaining the capacity to understand environmental conditions more accurately.