A ‘Shark Week’ blimp flies over the San Diego Convention Center on July 23, 2022. Aaronp/bauer-griffin | Gc Images | Getty Images
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Even so, allowing short-term emotion to guide long-term financial decisions is generally counter to investors’ best interests, as is often the case when selling stocks in a panic. Recency bias is akin to a common yet illogical human impulse, such as watching Steven Spielberg’s classic summer blockbuster “Jaws” and then being afraid of the water. “Would you want to go for a long ocean swim after watching ‘Jaws’? Probably not, even though the actual risk of being attacked by a shark is infinitesimally small,” wrote Omar Aguilar, CEO and chief investment officer at Schwab Asset Management. Fitzgerald equates the impulse to a bee sting. “If I get stung by a bee once or twice, I’m not going to go there again,” said Fitzgerald, a principal and founding member of Moisand Fitzgerald Tamayo. “The recent experience can override all logic.”
Recency bias is largely associated with FOMO
Here’s a recent real-world illustration. The financial services sector was among the top performers of the S&P 500 Index in 2019, when it yielded a 32% annual return. Investors who chased that performance and subsequently bought a bunch of financial services stocks “may have been disappointed” when the sector’s returns fell 2% in 2020, a year when the S&P 500 had a positive 18% return, Aguilar said.
Fans celebrate the June 14, 2005, release of the “Jaws” 30th Anniversary Edition DVD from Universal Studios Home Entertainment. Christopher Polk | Filmmagic | Getty Images
Among other examples posed by financial experts: tilting a portfolio more heavily toward U.S. stocks after a string of underwhelming performance in international stocks, and overreliance on a mutual fund’s recent performance history to guide a buying decision. “Short-term market moves caused by recency bias can sap long-term results, making it more difficult for clients to reach their financial goals,” Aguilar said. The concept generally boils down to fear of loss or a “fear of missing out” — or FOMO — based on market behavior, said Fitzgerald. More from Personal Finance:
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The fear of missing out can be a killer for investors Acting on that impulse is akin to timing the investment markets, which is never a good idea. It often leads to buying high and selling low, he said. Investors are most vulnerable to recency bias, he said, when on the precipice of a major life change such as retirement, when market gyrations may seem especially scary.
What’s in a well-diversified portfolio
Long-term investors with a well-diversified portfolio can feel confident about riding out a storm instead of panic selling, however. Such a portfolio generally has broad exposure to the equity markets, via large-, mid- and small-cap stocks, as well as foreign stocks and maybe real estate, Fitzgerald said. It also holds short- and intermediate-term bonds, and maybe a sliver of cash, he added.