If I tell you, I flipped a coin 5 times and all the time I got head. What will be the outcome on 6th flip? Most of us will say head.
Then I tell you that before this when the coin was flipped 20 times, the outcome was 50% head and 50% tail. After this information, we may get a little hesitant in calling out the outcome as head on the 6th flip but mostly still go with the head.
This phenomenon is called recency bias. And it plays a dominant role in the world of investments.
When the markets keep rising over the recent past, without much correction, most of us start believing that it will continue to rise in the future as well without much downside.
The market participants ride this bias and talk about eye-popping recent gains. The media shouts at the top of its voice to sensationalize this further. Only a few will present a longer picture of the market history.
Unfortunately, every time the market gains, people increase their stake with the expectation of superlative returns to continue. And that increases the overall risk in the investment portfolio. At some point, the markets correct resulting in value erosion and regret.
However, the good part is that if we understand that we are impacted by the recency bias, we can work over it.
To overcome this bias, one should read the market history of at least the last 50 years in detail, not just of India but international more developed markets. This will help not just in safeguarding the hard-earned money in the downturn but also present a great opportunity to invest at cheaper prices.
Concluding this post with a quote from Carl Richards “If you are not aware of recency bias, it can wreak havoc in your life. The only solution I have come across is to lengthen your definition of the recent past.”
Originally posted on LinkedIn: www.linkedin.com/sumitduseja
Truemind Capital is a SEBI Registered Investment Management & Personal Finance Advisory platform. You can write to us at connect@truemindcapital.com or call us at 9999505324.
