As an investor, it’s easy to fall prey to “recency bias” – the tendency to base investment decisions on recent market performance rather than taking a broader and more forward-looking perspective.
Fighting the last war is a natural human tendency that results from our innate desire to find patterns and make sense of the world around us. But, in the world of investing, this can be a dangerous mindset to adopt. For example, after the 2008 financial crisis, many investors rushed to allocate billions of dollars to so-called “black swan” strategies that were designed to protect against rare and extreme events. This reaction was misguided, though. It came after the feared black swan, and at that point, was a useless strategy.
A more drastic example? A study conducted by Fidelity Investments on their flagship Magellan fund, during Peter Lynch’s famed tenure, from 1977-1990. His average annual return during this period was 29%, as compared to 14.47% of the S&P 500 index. This is a remarkable return over the 13-year period and made him one of the best investors ever. It was clear that investors were aware of the fund’s stellar performance as inflows made it one of the largest mutual funds of its time. Given that amazing performance, you would expect that Magellan Fund investors got really rich during Lynch’s tenure. Shockingly, a study by Fidelity Investments found otherwise. The average investor lost money under Lynch’s leadership. Rub your eyes and read that again: The average investor lost money in the Fidelity Magellan fund under Peter Lynch’s tenure during a period of time when the fund returned around 29% annually. How did the average investor lose out on Magellan’s success?
Markets swing up and down. When the market went up, the Magellan fund rose even higher. This excited and enticed investors who rushed to invest. But when the market and the fund declined, investors immediately sold. At every robust period, investors moved money into the fund, and at every decline, they sold – with Magellan’s value swinging lower than before. Recency bias killed Magellan’s performance.
Similarly, in the current market environment, investors are reacting to what worked in 2022, without considering whether those strategies will continue to be successful in the future. To avoid the pitfalls of fighting the last war, investors must adopt a progressive approach. This means taking a longer-term view of the investment landscape and considering how trends and risks might evolve over time. By focusing on the future, investors can avoid getting caught up in short-term market movements and can make better-informed investment decisions.
Be aware of this tendency, and look out of the windshield as opposed to the rear-view mirror. You’ll make more knowledgeable investment decisions and avoid getting caught off guard by unexpected events. You won’t get caught up in the latest market fads. Instead, you’ll be primed for long-term financial success.
This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for, legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
