How to combat the recency effect

Posted by TEBI on June 5, 2024

How to combat the recency effect





As a regular viewer of Match of the Day, I’m often struck by how managers are able to remain so composed when interviewed after a defeat. They may have every reason to lose their cool, like Kevin Keegan famously did in a post-match rant in 1996, and yet they generally manage to stay remarkably level-headed.

So how do they do it? The main reason is that Premier League clubs now employ behavioural coaches to work with managers and players. Clubs realise the importance of maintaining psychological focus throughout the season and taking inevitable setbacks on the chin, whether that’s losing in the final minute or being on the wrong end of a controversial VAR decision.

Investors too can benefit from behavioural coaching. In the markets, as in sport, the prevailing  mood can change very quickly. Share prices can steadily rise for months and then suddenly fall sharply. Luck, both good and bad, also plays a part. You may, for instance, invest your annual bonus or a small inheritance in the stock market the day before a sharp correction, but the next time you do it you might just catch the start of a bull run. The important thing is to keep your focus on your long-term goals, and to resist the tendency to let recent or current events lead you into making irrational decisions.


The recency effect

Behavioural psychologists call this phenomenon recency bias, or the recency effect. The term refers to our tendency to give more weight to the most recently presented information than information presented earlier. Other examples are the way that people stop flying after a plane crash or take out earthquake insurance immediately after an earthquake.

It’s perfectly natural that we display these behaviours. It’s the way our minds, and particularly our memories, have evolved. For early humans, recent observations about weather conditions, predator movement or the availability of resources were crucial for survival. The recency effect would help to prioritise this fresh, and potentially critical, information.

The problem is that, when it comes to investing, our tendency to focus on recent events and what’s happening right now can be very unhelpful. Why? Well, the simplest and most reliable way to invest is to have a broadly diversified portfolio and benefit from the miracle of compounding by holding it for a very long time. All the evidence tells us that chopping and changing our portfolio, and jumping in and out of the market, reduces our eventual returns. Recent and current events contract our time horizon and tempt us to act in ways that might give us short-term comfort but which we will probably come to regret.



Here are some articles you may also enjoy:

What should you do in a bear market?

Prediction addiction: do you suffer from it?

Overcome your fear of the stock market


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