Recency bias

In short

A friend of mine once sold every stock he owned after a bad month, then sat in cash for two years while the market climbed. You can probably guess how he felt. Recency bias is the habit of giving too much weight to whatever happened lately. You can guard against it, and the steps are simple. Write down your plan when you feel calm, and keep it where you can find it. Look at your account less often, and check a long stretch of history before you act on a short one. Wait a few days before any big move made in a hurry. You are not weak for feeling the pull. Every one of us does.

The whole of it

What it is

I once watched a neighbor pick a restaurant by the last meal he ate there. One bad night, and he would not go back for years, even though the place had served him well a hundred times. That is recency bias, and it is as human as anything I know. The mind treats fresh events as if they matter most, and old events as if they barely happened.

If you are holding an investment account, you have probably felt this. After a run of good news, the good times seem like they will last forever. After a run of bad news, the bad times seem just as permanent. Neither feeling is a forecast. Each one is only the mood of the last few weeks, dressed up as wisdom.

Researchers who study behavior have written about this for a long time. Daniel Kahneman and Amos Tversky described how people judge by what comes easily to mind, in a paper called Judgment under Uncertainty: Heuristics and Biases, published in the journal Science in 1974. Recent events come to mind easily. So they feel larger than they are.

How it works

A story helps here. A woman I know keeps a garden, and she told me she never trusts the first warm week of spring. She has been fooled too often. The frost comes back. So she waits. She has learned that one warm week tells her little about the whole season.

Money works the same way, and yet we forget it. When prices fall for a month, the falling feels like the whole story. When prices rise for a year, the rising feels like a law of nature. The mind stretches the recent trend into the future, as if a line on a chart had promised to keep going.

Here is where it costs real money. A person who sells after a drop locks in the loss. A person who buys after a big climb pays a higher price than before. Nothing about this is foolish on its face. It only feels sensible in the moment, and that is the trap. The feeling and the facts have quietly parted ways.

Fees and taxes make it worse. If you sell in a taxable account, you may owe tax on any gain. Each trade can also carry a cost. Those costs are real, and they come out of your pocket whether or not the move was wise.

The numbers, and where to find yours

You do not need many numbers to see this bias at work. You need your own. Start with your account statement, which shows what you paid and what you hold now. Look at the change over one month, then over one year, then over as many years as you have owned it. The three views often feel very different. Try it. You may be surprised.

Some limits matter if you save for retirement. The most you can put into a 401(k) in one year is the current figure, which the official source publishes each year, set by law and updated by the IRS. The limit for an IRA is the current figure, which the official source publishes each year. Those figures change by year, so check the official page rather than trust a memory. The IRS publishes them at irs.gov, and your plan administrator can confirm what applies to you.

If you are at least the age set by law for catch up contributions, which is the current figure, which the official source publishes each year, you may be allowed to add more. Your own plan documents will say how. Look them over when you have a quiet hour.

A worked example

Let me tell you about a man named Carl. He earns 52,000 dollars a year and puts 6 percent of his pay into his retirement plan. His employer matches 3 percent. Now let me show the sums so you can check them.

Six percent of 52,000 dollars is 52,000 times 0.06, which is 3,120 dollars a year. The employer match is 3 percent of 52,000, which is 52,000 times 0.03, or 1,560 dollars. Add the two together, and 3,120 plus 1,560 gives 4,680 dollars going in each year.

Now suppose the market has a rough season and Carl's balance drops. He is scared. He decides to stop his contributions for a year. What does that cost him? He gives up his own 3,120 dollars. He also gives up the 1,560 dollars from his employer, since the match depends on his saving. That is 3,120 plus 1,560, or 4,680 dollars that never went in.

Carl did not mean to turn down free money. He was reacting to the last few months. His plan on paper called for steady saving, and one bad stretch talked him out of it. Had he read his own written plan first, he might have stayed the course. Or he might have changed it for good reasons. Either way, the choice would have been his own, and not his fear's.

There is a small lesson in Carl's story. The bad season did not last, but the missed savings were gone for good. Time in the plan matters. So does staying in it.

Where it goes wrong

I have made this mistake myself, so I say it gently. The first way it goes wrong is chasing. A fund does well for a year, and everyone talks about it. You want in. But last year's winner has no promise attached to it. The official documents from fund companies carry a line saying past performance does not guarantee future results, and that line is there for a reason. The Securities and Exchange Commission requires it.

The second way is fleeing. Prices fall, headlines shout, and you want out. Selling feels like safety. Yet it can lock in a loss that might have healed with patience. It also may leave you with the harder task of deciding when to come back.

The third way is quieter. You stop looking at the whole picture. You forget the years of steady progress because one loud month drowned them out. This one is easy to miss. It hides behind good sense.

The fourth way is checking too often. A person who looks at a balance every day sees every wobble. Each wobble tugs at the heart. Looking less often is not laziness. It is a kind of kindness to yourself.

One more caution, and it is a plain one. I cannot tell you what to buy, sell, or hold. I can only tell you how the habit works and what it may cost. The decisions belong to you, and you are the right person to make them.

Questions to answer before you leave this page

When did you last make a money choice within a day of hearing bad or great news, and how did it turn out? What does your written plan say, and have you put it down on paper where you can find it? If you looked at your account over ten years instead of one month, what would you see? Which of your contributions, tax costs, or trading fees would change if you waited three days before acting? Who is one person you trust that you could call before you make a big move? And what would you like your future self to thank you for?