*Raina has just started investing in stocks, and she invested in the most trending stock. She lost 50% of the value of her investment within a year and immediately withdrew the investment. That is when her friend Priya advised her not to fall prey to Recency bias and explained the meaning to her.
(Note: The above example is for illustration purpose only)
What is Recency Bias?
Recency bias, by definition, is a cognitive bias when decisions are taken based on recent events and not a complete analysis. Overemphasis is laid on recent events leading to incomplete information. Say, an employee close to the appraisal cycle does not perform well; his manager rates him accordingly. All the excellent work done in prior months is ignored. This is Recency Bias, and it is seen in investing as well. When markets are performing well, everyone will start investing, forgetting the not-so-recent crash in the stock market. Similarly, when the markets are not performing well, everyone will start selling, forgetting that the markets will recover soon. Recency Bias in investing may reflect in all forms of investing like mutual funds , gold, and real estate.
Why does recency bias occur?
Recency bias is based on the fact that our short-term memory can hold only a certain amount of information, and we recall that to base our decisions on. Since this information is readily available, the effort required to recall is minimal, and decisions can be taken quickly. So, if the stock market is booming, people will be seen buying because they think prices will keep rising when the reverse is true.
Recency bias in investing
Recency bias can be witnessed in all areas of life. But, it can cause losses when it interferes with investment decisions. This explains panic selling or frenzy buying in stock markets. Recent performance is given more weightage than long-term performance. The impact of recent events and the weightage added to them determine the decisions, which could be detrimental to the investor's financial interests.
Recency Bias Example
Example 1
Let us see the weather reports for a city:
| Year | Weather Status |
| 2020 | No Rainfall in June |
| 2021 | Scanty Rainfall in June |
| 2022 | Heavy Rainfall in June |
So, when Mr Sharma is asked about his prediction of the rainfall for this year - 2023, he promptly replies that it will be heavy as last year. All the data from previous years is ignored as recency bias makes him recall only last year's events.
Example 2
Let us see Mutual Fund A’s and Mutual Fund B's performance:
| Mutual Fund A | Mutual Fund B |
| Performance in the last six months | +2% | +1% |
| Performance in the previous three years | -3% | +3% |
| Performance in the last five years | +1% | +5% |
An investor looking to invest in mutual funds may invest in A, as its recent performance compared to B is better. But if a thorough analysis is conducted, it is evident that B is a relatively stable and safer investment.
Additional Read: What is NAV?
How to Avoid Recency Bias?
The following table illustrates the steps to be taken to avoid recency bias:
Let us understand each of them:
1. Know the Market/Business Cycle – Stock markets and businesses may follow periodic cycle. It is not always low or high. It is cyclic; after every low (bear market), there can be a high (bull market), and it goes on. Knowing where you stand as an investor helps frame a strategy that will work.
2. Draw Financial Goals and Invest - Financial goals are where you would like to reach regarding money. Having goals and detailed strategies to meet each goal, be it short-term, medium-term or long-term, is necessary to decide your investment and avoid any irrational decisions.
3. Asset Allocation - With your financial goals in place, you can build your portfolio and decide the asset allocation. The motive must be to review the overall portfolio's performance and regularly rebalance the asset allocation.
4. Consult Professional - An expert or a professional like a financial advisor possesses the requisite knowledge and skill set to guide your investment management. Whenever there is a panic, always take the opinion of experts before taking any hasty decision.
5. Have a broader vision - When investing, look at the bigger picture of your portfolio, goals, and investments. Ensure your assets and portfolio are aligned with your goals and as per the market cycle, as investing is always about long-term and broader views.
Recency bias is when an investor gives too much importance to recent events and makes decisions based on them, which eventually causes regret. It impacts all areas of life, but when it affects investment decisions, it can cause a loss. Investing must be a rational decision; hence, an awareness of recency bias can help overcome it.
Additional Read: Things to Know before investing in Mutual Fund
Helpful information for investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/ Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in . For more info on KYC, change in various details & redressal of complaints, visit mf.nipponindiaim.com/InvestorEducation/what-to-know-when-investing.htm This is an investor education and awareness initiative by Nippon India Mutual Fund.
Disclaimer:
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.
