Recency Bias: Why the Last 12 Months Distort Your View of the Future

This is recency bias: the tendency to assume that recent patterns will continue, even when history shows they rarely do.

What Recency Bias Is#

Recency bias is the cognitive tendency to give disproportionate weight to recent events when forming expectations about the future.^¹ The most recent information feels most relevant, most vivid, and most predictive - even when it is not.

In psychology, this is related to the availability heuristic: we judge the likelihood of events based on how easily examples come to mind.^² Recent events are easier to recall than distant ones, so they dominate our mental models.

For investors, recency bias manifests as the assumption that recent market conditions, sector performance, or investment returns will persist. After a bull market, investors expect more gains. After a bear market, investors expect more losses. Both expectations are statistically unreliable.

How Recency Bias Affects Investment Decisions#

Performance Chasing#

The most common manifestation is performance chasing: buying what has performed well recently and avoiding what has performed poorly.

Fund flow data consistently shows that investors pour money into funds after strong performance and withdraw after weak performance.^³ This is the opposite of "buy low, sell high." It is buying high (after prices have risen) and selling low (after prices have fallen).

Research shows that the funds receiving the most inflows often underperform in subsequent years, while the funds experiencing outflows often recover.^⁴

Sector and Style Rotation#

Recency bias drives cycles of sector enthusiasm. After technology stocks outperform, technology allocations increase. After value stocks outperform, value allocations increase. These shifts often occur just as the recent trend is about to reverse.

The pattern is consistent: investors chase the hot sector, arriving late to the party and holding through the subsequent underperformance.

Post-Crisis Paralysis#

After market crashes, recency bias makes investors reluctant to reinvest. The pain of recent losses dominates expectations, making future gains seem unlikely or irrelevant.

Investors who sold during the 2008 financial crisis and waited for "stability" before reinvesting missed substantial recovery gains. The same pattern repeated after the 2020 COVID crash. Recency bias keeps investors on the sidelines precisely when expected returns are highest.

Extrapolating Economic Conditions#

Recency bias extends beyond markets to economic forecasting. After a recession, investors expect prolonged weakness. After expansion, investors expect continued growth. These extrapolations ignore the cyclical nature of economies.

Why Recency Bias Persists#

Evolutionary Wiring#

In ancestral environments, recent information was usually the best predictor of near-term conditions. If predators were spotted yesterday, they are likely nearby today. This heuristic served survival well in a world of physical threats.

Financial markets do not work this way. Past returns are a poor predictor of future returns, especially over short time frames. But our brains did not evolve for investing.

Narrative Construction#

Humans are storytelling creatures. Recent events provide the raw material for narratives that explain what is happening and predict what will happen next.^⁵

After a strong market year, the narrative might be: "The economy is recovering, corporate earnings are growing, and conditions favour continued gains." This story feels coherent and predictive, even though it is just a description of the recent past dressed up as a forecast.

Emotional Salience#

Recent events carry emotional weight that distant events lack. The pain of a recent loss or the pleasure of a recent gain is viscerally present in a way that historical data is not.

This emotional salience makes recent events feel more predictive than they actually are.

Media Amplification#

Financial media intensifies recency bias by constantly covering recent performance. "Best-performing funds this year" and "worst sectors this quarter" are standard content, reinforcing the sense that recent trends are meaningful predictors.

Evidence-Based Strategies to Counter Recency Bias#

1. Study Long-Term Historical Data#

Deliberately expose yourself to long time series that show how variable performance is over time.^⁶ Looking at 50+ years of market returns reveals:

• Strong years are often followed by weak years, and vice versa
• The best decades and worst decades look nothing alike
• Mean reversion is a persistent pattern (though timing is unpredictable)

This historical perspective creates a counterweight to the vividness of recent experience.

2. Use Base Rates#

Base rates are the historical frequency of outcomes across many instances, not just recent ones.^⁷ Before assuming recent performance will continue, ask:

• "How often do top-performing funds repeat their performance the following year?" (Answer: rarely)
• "How often do markets continue falling after a 30% drop?" (Answer: less often than they recover)
• "What is the historical average return over 10-year periods?" (Answer: moderately positive for diversified portfolios)

Base rates provide a more reliable foundation for expectations than recent experience alone.

3. Implement Rules-Based Investing#

Systematic, rules-based approaches remove recency bias from decision-making.^⁸ Examples:

• Rebalancing: Automatically selling winners and buying losers brings portfolios back to target allocations, counteracting performance chasing.
• Dollar-cost averaging: Investing fixed amounts on a schedule ignores recent performance entirely.
• Target-date strategies: Allocation shifts based on time horizon, not recent market conditions.

These rules enforce behaviour that recency-biased intuition would resist.

4. Wait Before Acting#

Recency bias is strongest immediately after notable events. Implementing a waiting period before making changes allows the emotional salience of recent events to fade.

Some investors adopt a waiting rule: at least 30 days after any significant market move before making discretionary changes. The delay allows more rational assessment and reduces the influence of recency on the decision.

5. Consider the Counter-Scenario#

Before acting on recent trends, explicitly consider the opposite scenario:

• "What if this recent strength is the end of the cycle rather than the middle?"
• "What if this recent weakness is the bottom rather than the beginning of a decline?"
• "What if the last 12 months are an outlier rather than the new normal?"

This mental exercise counteracts the assumption that recent trends will continue.

6. Diversify Across Conditions#

Since we cannot reliably predict which recent trends will persist and which will reverse, diversification across different asset classes, sectors, and styles ensures that no single recency-driven bet dominates the portfolio.

Diversification is the structural solution to the uncertainty that recency bias ignores.

7. Keep a Decision Journal#

Document your reasoning when making investment decisions, including what recent events influenced your thinking.^⁹ Review this journal periodically to see how often recent conditions persisted as expected.

Pattern recognition across your own decisions can reveal how often recency bias led you astray.

Mean Reversion: The Statistical Reality#

One of the most robust patterns in financial data is mean reversion: periods of above-average returns tend to be followed by below-average returns, and vice versa.^¹⁰

This does not mean:

• Markets are predictable (timing reversals is extremely difficult)
• Every winner will become a loser (some outperformance is genuine)
• Buying losers always works (some investments decline for good reasons)

It does mean:

• Extrapolating recent performance is statistically unreliable
• The best and worst performers are unlikely to repeat
• Diversification and rebalancing have a statistical foundation

Understanding mean reversion helps counteract the recency-driven assumption that recent trends will continue.

Recognising Recency Bias in Yourself#

Signs that recency bias may be affecting your judgment:

• You want to increase allocation to whatever performed best recently
• You want to avoid or sell whatever performed worst recently
• Your market outlook is essentially a description of the last 12 months extended forward
• You feel confident predicting near-term market direction based on recent trends
• Recent events feel like "the new normal" rather than cyclical variation

Summary#

Recency bias causes investors to overweight recent performance when forming expectations about the future, leading to performance chasing (buying high after gains, selling low after losses), sector rotation at the wrong times, post-crisis paralysis, and unrealistic extrapolation of economic conditions. Evidence-based countermeasures include: studying long-term historical data to provide perspective, using base rates instead of recent experience for expectations, implementing rules-based investing that ignores recent performance, waiting before acting on recent events, considering counter-scenarios, maintaining diversification, and keeping a decision journal. Mean reversion - the tendency for extreme performance to moderate - is a statistical reality that contradicts recency-driven assumptions.

Sources#

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1. Kahneman, D. (2011). Thinking, Fast and Slow. Farrar, Straus and Giroux.

1. Frazzini, A., & Lamont, O. A. (2008). Dumb money: Mutual fund flows and the cross-section of stock returns. Journal of Financial Economics, 88(2), 299-322. https://doi.org/10.1016/j.jfineco.2007.07.001

1. Morningstar. (2023). Mind the Gap 2023. https://www.morningstar.com/lp/mind-the-gap

1. Shiller, R. J. (2019). Narrative Economics: How Stories Go Viral and Drive Major Economic Events. Princeton University Press.

1. Siegel, J. J. (2014). Stocks for the Long Run (5th ed.). McGraw-Hill Education.

1. Kahneman, D., & Tversky, A. (1973). On the psychology of prediction. Psychological Review, 80(4), 237-251. https://doi.org/10.1037/h0034747

1. Malkiel, B. G. (2019). A Random Walk Down Wall Street (12th ed.). W. W. Norton & Company.

1. Richards, C. (2012). The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money. Portfolio.

1. Poterba, J. M., & Summers, L. H. (1988). Mean reversion in stock prices: Evidence and implications. Journal of Financial Economics, 22(1), 27-59. https://doi.org/10.1016/0304-405X(88)90021-9