The cost of regency bias
2018 was a difficult year, one of the most difficult of my career. An overriding pessimism enveloped us: Trump was fighting with China over trade, Brexit turned out to be a big mess, Europe stood, once again, on the precipice of a recession, the currency declined, South Africans learnt more about the extent of our leader’s corruption and financial markets tanked. Some analysts reckon it was the worst broad-based decline in financial market history.
At the end of 2018, we were deeply depressed.
We could not envisage a turnaround. The fundamentals of the immediate future looked bleak. We could only imagine a future that looked just like our immediate past.
Most of us did not anticipate what happened next. World markets rallied by 10% in January and continued to speed ahead in February. The South African equity market put in its best start in 12 years gaining 10% to the end of June.
Let’s hope you didn’t act on your depression in December. Let’s hope you didn’t sell your shares. You would have missed out on a swift turnaround, wiping out most of your losses suffered in the previous year.
Now we have no way of knowing whether the last six months are any indication of the months ahead, but as humans we too frequently let ourselves be swayed by the recent past. It’s called recency bias.
Recency bias is all around us. It’s why we’ll bet on the Bulls when they’ve had a winning streak. It’s why people don’t clean their gutters during droughts. It’s why people buy on credit when interest rates are low.
But those trends can turn around, sometimes unexpectedly and against all odds. Then you have lost on your sure bet, your house is flooded because you haven’t provided for rain and you cannot afford your bond repayment.
In investments, recency bias cause investors to withhold savings when returns are poor, which means they lose out on the good returns to follow. Or it leads investors to pile into the most recent ‘sure thing’. Think of the recent property market experience – the spectacular returns lured investors to invest when times were good only to find a dearth of tenants months later
Recency bias is costly in investments and in life. Be aware. The most recent past may not repeat itself.
//12 July 2019