Latest things are always welcomed, be it fashion or news. We call it updating ourselves but do we consciously think how much weightage are we giving to the latest updates?.......err!! May be not. Economics and financial theories have considered human mind a rational one which is now accepted as irrational. Finally, behavioural sciences have given us reason to accept the practicality of human mind. Yes! Our most of the decisions are driven by emotions. When you drill down your actions to very basic level; Love, Greed & fear would be the driving forces. A rational mind which has all this information would decide for best available option but we all know what mostly happens; a delicious lunch spread has salads & sprouts too as well as other fattening sweets & dishes too; we make excuses to shut the rational mind up.
Now, as we accept irrationality of human mind, it is important to understand that it is applicable to investment choices and decisions as well. A very important bias is currently at play in stock market; Investors are freaking out & are low on confidence. Some wise businessmen are sharing that they are saved from fall because they didn’t invest in stock market at all.
An awareness towards behavioural biases can empower us to take better decisions & It propels us to understand Recency Bias. It lures investors into buying recent high performing funds which may be at their maximum valuations & It also triggers panic selling on some XYZ news or belief. We process information step by step; each new information forms different impression and the belief is updated which creates impression of latest information being most important; & so recency bias leads to overweigh most recent information available to us. We regularly encounter these phenomena in our day to day life. For example;
During the appraisal phase in a company, employees tend to put in more hours at work to build a positive image which could lead to managers evaluating employees on their recent performance rather their performance during the entire year.
A trader made profit on 32 of 40 trades, but if loss making trades are last 8 continuous trades, a distorted view and emotional mistakes are bound to happen. Similarly, if last 8 trades were profitable, trader would feel happy and confident. These biases do not let investor to stick to his trading or investment plan which might result in huge losses.
It is a recurring phenomenon in film industry where after one huge hit actors demand more fees, even though they cannot guarantee a hit film but producers pay them as they also want to cash in on public’s short-term euphoria around popularity of actor. It is no rocket science to understand that if an actor who gave one ?400 cr film in 3 years or someone like Akshay Kumar who gave 7 hits in three years making ?1400 cr, is more dependable.
So, being mindful and aware towards the bias can be helpful. For example, you started SIP in a good performing mutual fund for 10 years timeline/goal, now the fall is disturbing you, the red in portfolio bleeds your heart but you have to consciously remind yourself about being invested for 10 years. A food for thought in the end to understand importance of processing information in total rather than recent ones.
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