Past Performance is No Guarantee of Future Results…

Recency bias

Anyone who has studied a document which illustrates the financial returns of a particular investment is most likely familiar with these words. The regulatory bodies require this disclaimer to be included with any reporting of investment results. While the regulators seek to prevent unscrupulous sales personnel from overpromising results, these words also sum up our next behavioral finance bias. Recency bias has caused many an investor to be disappointed with their selection of a particular security.

Recency bias causes us to place an inordinate degree of importance on the very recent past when we make investment decisions. It has been well established in research work by Dalbar1, among others, that individual investors often underperform the results of most mutual funds due to “performance chasing.” This is often observed among 401k investors who switch from fund to fund rather than maintaining a well-diversified portfolio. When asked about their decision process, these investors state, “I just looked at the 3-month (or 1-year) results and picked the fund that was doing the best.”

While there is some observed “investment momentum”, especially with individual stocks, performance chasing generally leads to sub-optimal outcomes. The financial markets are continuously responding to new economic data as well as other types of information. Our world is a constantly changing place and it is important to be aware of our human tendency to expect the near future to be a continuation of the recent past. Investors should maintain a well-diversified portfolio as it maintains exposure to many areas of the financial markets. Portfolio diversification and periodic rebalancing can help to neutralize our human tendency to be overly influenced by recency bias.        

If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240.  This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any transaction.

1Dalbar Quantitative Analysis of Investor Behavior has been conducted annually since 1994.

Certified Financial Planner