Behavioural Biases In Investing
06 November 2016
How many of us can really remember something which happened 10 or 15 years ago? Perhaps we could, if it was a life changing event, but even then the details would be hazy. Our mind remembers the general context and the broad picture, but the colour of the shoes you were wearing or when it started to rain would be lost in time.
The Recency Illusion is a term invented by Arnold Zwicky, a Stanford linguist who was interested in examples involving words, meanings, phrases and grammatical construction. However, the term is not restricted only to linguistics; Zwicky defined it as “the belief that things you have noticed only recently are in fact recent”.
Unfortunately, in the realm of our mind, this is true. Recent events and the current informational context have the most weight in determining how we interpret things. This is particularly troubling when applied to investing. How many times have you heard someone say, “I am going to buy this house or this stock because it won’t lose money. I don’t know anyone who didn’t get rich doing this!”
The recency illusion also affects those who write the articles which we devour daily and base our decisions on. Here are some famous examples that generally went pear-shaped for anyone who followed the headlines:
First, we have the infamous Business Week cover heralding the death of equities – which, after a 18 year consolidation period, preceded one of the best equity bull markets. It is likely that investors whom the journalists spoke to had grown weary of holding stocks, as they provided close to no returns.
The Time magazine cover on the housing bubble in the US likewise preceded one of the biggest housing busts, which led to the 2008 Great Financial Crisis.
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