At LPL Research, we believe one of the keys to successful investing rests with our own individual ability to overcome basic human tendencies and emotions.  Some of these tendencies have been defined and are part of the research umbrella we now call behavioral finance or behavioral economics.

In this latest edition of LPL Street View, Chief Investment Officer Marc Zabicki unpacks one of those tendencies we call “recency bias.”  This is the human inclination to place too much emphasis on experiences that are freshest in our memories.  In the world of investing, it can mean assuming market returns or market conditions in one quarter or one year will continue into the subsequent period.

We believe one way to combat recency bias is to constantly recall that financial market decision-makers are prone to irrational behavior.  It’s human nature to be irrational at times—even professional investors can fall victim if they are not careful.  Because market prices can vary materially from rational equilibrium at times, extrapolating recent market returns into the next period can often be a mistake.  It’s a good idea for investors to engage in some rational homework to assess if recent market returns are in line with developing fundamentals or if they have been influenced by irrational sentiment.

Another way to combat recency bias is to adopt a contrarian investing approach.  An individual adopting a contrarian approach often looks for market opportunities that go against consensus or against current market sentiment.  However, we have to be careful of blindly adopting a contrarian approach. We have to do our homework as well. Paying close attention to price deviations from the norm can often lay the foundation for a good contrarian decision.

Finally, and perhaps the easiest way to combat recency bias—have a plan.  If you have decided to set aside tactical asset allocation in favor of a systematic, longer-term investing strategy, (one that rebalances toward an out-of-favor asset class on a quarterly or annual basis) the effect of recency bias on your portfolio may be minimized.  In fact, having a plan and sticking steadfastly to it may be the easiest and most effective tonic against various human biases.

Regardless of your approach, we believe combatting recency bias and/or other human tendencies is an important step toward the development of a formidable wealth-building strategy. 

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This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth in the podcast may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. All indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index data is from FactSet.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This Research material was prepared by LPL Financial, LLC. 


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