Recency bias is the tendency for individuals to recall and emphasise the most recent events as opposed to those in the past. Furthermore, if the event has not been experienced, individuals will tend to ignore the event. This was promulgated on the serial position effect[1], which is the tendency to recall the first and last event in a series and forget the middle. It’s a natural heuristic process as it requires less energy and time to remember two nodes and infer the path.
Investors naturally extrapolate current events into the future, in a linear regression fashion, conveniently forgetting that market events move in a sinusoidal manner. This results in investors being overweight growth at the end of bull markets and panic selling at the end of bear markets.
To counter this bias, we need to educate the investor that history moves in waves, and the most damage done to an investor portfolio is self-inflicted. Tackling recency bias is important, in the advice sequence as once investors are overweight growth during a downturn, loss aversion[1] and panic set in, and managing client expectations in that scenario becomes extremely difficult.
[1] Refer Prospect Theory.
[1] Ebbinghaus, Hermann (1913). On memory: A contribution to experimental psychology. New York: Teachers College.