Recency Bias in Investing: Why Last Month Feels More Real Than Last Decade
Imagine you are on a cruise ship. Over the entire trip, you see exactly the same number of green boats and blue boats. But most of the green ones pass by toward the end of the trip, and the blue ones are spread out earlier. When you get home, which color do you remember seeing more? Green. Obviously green. You saw so many of them.
Except you did not. You saw the same number of each. Your brain just weighted the recent observations more heavily. This is recency bias, and Chapter 16 of Pompian’s book makes a strong case that it is responsible for some of the most expensive mistakes investors make.
Your Brain Has a Short Memory
The technical explanation for recency bias comes from memory research. Psychologists use something called a “serial position curve” to show what people remember from a list of items. It is U-shaped. People remember the first few items well (primacy effect) and the last few items very well (recency effect). Everything in the middle gets forgotten.
The primacy effect works because early items get rehearsed more and make it into long-term memory. Think of it like your brain’s hard drive. The recency effect works because the last items are still in short-term memory. Like your computer’s RAM. Still fresh, easily accessible, but temporary.
This is fine for remembering shopping lists. But here is the problem: investors are constantly making decisions based on information lists. Economic data, earnings reports, market returns, analyst opinions. And the last piece of information always gets too much weight.
The Periodic Table of Investment Returns
Pompian introduces what practitioners call the “periodic table of investment returns.” It is a chart that shows how different asset classes performed each year, ranked from best to worst. And the pattern, or rather the lack of pattern, is striking.
The top-performing asset class in one year is frequently near the bottom the next year. Emerging markets might lead one year, then bonds, then U.S. large-cap stocks, then real estate. There is no consistent winner. The only thing that consistently shows up in the middle of the pack is a diversified portfolio.
This chart exists specifically to fight recency bias. When an investor comes in saying “I want all my money in whatever did best last year,” a good advisor pulls out this chart and says: look. Last year’s winner is often this year’s loser. Chasing recent performance is a losing strategy.
But recency bias is powerful. People look at this chart, nod, and then still want to buy whatever went up most recently.
The Bull Market Trap
Recency bias ran especially wild during the bull market of 2004 to 2007. Markets kept going up. Year after year of strong returns. Investors looked at the recent data and concluded: this is the new normal. Markets go up. That is what they do.
They forgot about bear markets. Not because bear markets are rare. They happen regularly. But the recent experience was so uniformly positive that it overwhelmed all historical knowledge. Investors’ short-term memories essentially overwrote their long-term understanding of how markets work.
This is how people end up buying at the top. They look at recent returns, project them forward, and assume the trend will continue. Then when the inevitable correction comes, they panic and sell at the bottom. Buy high, sell low. The exact opposite of what every investing book tells you to do. And recency bias is a primary driver.
“It’s Different This Time”
Pompian flags something that many experienced market veterans consider the most dangerous sentence in investing: “It’s different this time.”
In 1998 and 1999, during the dot-com bubble, people genuinely believed that traditional valuation metrics no longer applied. Companies with no revenue were worth billions. Price-to-earnings ratios that would have been insane in any other era were rationalized away. Why? Because recent experience showed that these stocks kept going up. The short-term memory of gains overwhelmed centuries of financial history.
It was not different. It never is.
When your own thinking or your client’s thinking starts going in that direction, it is time for what Pompian calls a “reality check.” Pull out the historical data. Show how every bubble in history followed the same pattern: rapid rise, irrational exuberance, crash, recovery. Nothing about the current situation is exempt from this cycle.
Montier’s Model: Irrational Expectations
The research section introduces a model by James Montier that I found particularly smart. He built a model of investor expectations using two components: anchoring (from the previous chapter) and recency.
For the anchoring part, he used the long-run real return of U.S. equities (about 7%) with a weight of 75%. For the recency part, he used the geometric 10-year annual price return with a weight of 25%.
The rational model said investors should expect about 5% real returns over the long run. But Montier’s “irrational” model, the one that includes anchoring and recency, showed investors expecting over 8% annually.
The gap between what investors irrationally expect and what is rational creates what Montier calls the “scope for disappointment.” When that gap is large, investors are setting themselves up for pain. And that gap was largest right before major market downturns.
This model also showed something interesting about the 1970s and early 1980s: irrational pessimism. After years of poor market performance, recency bias made investors expect continued poor returns. The recent bad experience overwhelmed the long-term historical average. Investors were too pessimistic, which means they missed opportunities.
Recency bias is not just a bull market problem. It works both ways. In good times, it makes you too optimistic. In bad times, it makes you too pessimistic. Either way, you are making decisions based on a narrow, recent window instead of the full picture.
Four Concrete Mistakes
Pompian lists four specific errors from recency bias.
Using too-small data samples. Investors project future returns based on one or three years of data when they should be looking at 10 or 20 years minimum. Small samples lead to buying at peaks and selling at troughs.
Ignoring value for price. When prices have been rising, people focus on price momentum and ignore whether the asset is actually fairly valued. Assets can and do become overvalued. Buying something just because it went up recently is not an investment strategy. It is recency bias with a brokerage account.
Ignoring diversification. When one asset class has been hot recently, investors concentrate their holdings there. They abandon proper asset allocation in favor of whatever is currently in fashion. This is how portfolios become dangerously unbalanced.
The big one: “It’s different this time.” Already covered above, but worth repeating. It is never different. Human nature does not change, market cycles do not stop, and recent performance is not a reliable predictor of future results, no matter how many times that legal disclaimer is printed on mutual fund prospectuses.
What Actually Helps
Education is the main antidote. Specifically, showing investors the data. The periodic table of investment returns. Long-term historical charts. Examples of past bubbles and recoveries. When people see the full picture, the recent data loses some of its hypnotic power.
Pompian also suggests something I like: the “advisory piggy bank” approach. Good advisors know they cannot criticize every bad idea a client has without damaging the relationship. So they save up their pushback for the moments that really matter. And when a client says “It’s different this time” or wants to put everything into one hot asset class, that is the moment to make a big withdrawal from the piggy bank and have a serious conversation.
For individual investors without advisors, the equivalent is: build rules for yourself when you are calm, and follow them when you are excited. Rebalance your portfolio on a schedule, not on a feeling. Look at 10-year data, not 1-year data. And every time your brain tells you that recent performance will definitely continue, remember the cruise ship. You saw the same number of boats. Your brain just does not remember it that way.
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Next: Loss Aversion
This is part of a series retelling “Behavioral Finance and Wealth Management” by Michael M. Pompian. Start from the beginning.