It’s simple. The Cubs have won eight of their last nine games. If that pace continues for the next nine games, the Cubs will win the World Series for the first time since 1908. Wouldn’t that be wonderful!
Yes, let’s hope the Cubs do, in fact, get to the World Series and win it. However, how they fared in the last nine games may or may not extend for the next series or two. We don’t know what’s coming, although we would certainly love to see a Cub dynasty for the next century as was forecasted in 1908, based on the 1907 and 1908 victories. As you can see, it’s easy to use our recent experience as the baseline for what we think will happen in the future. In behavioral terms this is called “recency bias.”
Behavioral biases can have a big impact on our decision making, particularly in investment matters. As Jason Zweig points out in his book “Your Money and Your Brain”: “When you win, lose, or risk money, you stir up some of the most profound emotions a human being can ever feel.” It’s a very important topic. Brett and I will be talking about some of these behavioral biases at our seminars in Palatine on October 28 and Mt. Pleasant on November 4th.
The recency bias is one of the reasons undisciplined investors chase performance and buy high and sell low. When a bull market keeps rising, it’s not surprising that people will forget about the ups and downs in a typical market cycle and believe this upward trend will last forever. They keep adding more equities to their allocation and then are shocked when the bubble bursts.
Similarly, when the market is down, they become convinced that it will never go up again and emotionally want to put their money in a mattress. When investors sell low they are typically victims of the recency bias. Of course, these same folks will “jump back in” after the markets have come back and by then have missed out on much of the recovery.
Recent events are easier to remember and understand than either events in the distant past or unknown events in the future. Rather than doing the hard work of analyzing/understanding the full range of possibilities (both positive and negative) in the future and assessing/understanding probabilities to each, investors emotionally really don’t want to be “confused with facts”. Using recent events to make quick decisions is easier and in many circumstances in our daily lives it can work well. However, recency bias can be a problem when it impacts our investment decisions.
Recency bias gets amplified in down markets. Behavioral finance has demonstrated that fear is a stronger emotion that greed. So, in a year like 2015, when, after a strong January and February, the markets first go sideways and then start declining, the fear of losing money coupled with the recency bias of a weak market naturally causes people to worry about their funds, and for undisciplined investors to want to put money into cash.
Behavioral finance is a tremendously interesting topic. We look forward to seeing many of you at our seminars where we will discuss more about investor biases and how to avoid falling prey to them. And, perhaps by the time we meet, the Cubs will actually be on their way to winning the World Series. Let’s hope the prediction from the movie “Back to the Future 2” comes true. Go Cubs!