Vihaan, who only started investing recently, sent Aanya a snapshot of the LV Bank stock with the text “Don’t miss out, because I’m gonna be rich!”.
This snapshot showed her the rise in LV Bank’s stock price over the last 3 months. Vihaan then invested his entire yearly bonus in this stock and at the end of the month, Aanya was the one buying the Sangrias when they went out.
Mentioned above, is an example of how biases play a critical role in our decision making. When finances are involved, this can lead to a make or break situation. One such evil is recency bias, which, if not identified and acknowledged, can severely derail a person from reaching their financial goals.
Recency bias is the unfounded belief that most recent trends will extend to the short-mid term. This is the same belief which makes managers give relatively higher appraisal ratings for people who have shown high impact in the last quarter of the year, than the consistent performers. Moreover, in the investing context, this is the primary reason which prevents investors from achieving higher returns on their investments over time.
A 2020 study by Cerulli Associates (“BeFi Barometer 2020”) found that Millennials are most likely to be affected by this behavioural bias. This makes us most susceptible to this trap and identifying ways to not let this influence our financial decision making is important for us to stay on track to retire early and/ or reach our desired investment goals.
So, what exactly should we do to remove this bias from our decision making?
Well, while looking at the big picture, understanding macro-economic trends and reading analyst reports can help, this is honestly time consuming and is a process filled with financial jargon. According to us, the best approach to overcome this bias is actually changing our approach on how we look at long-term investing.
Long-term investing has ideologically been thought of as a buy and hold concept. If I get my bonus today, I’m going to put it all in the hot new company and keep that for the next 10 odd years- This is what is going to make me wealthy!
But, rather than looking at investing as a one-time thing, we need to plan it systematically based on our financial goals.
Here are a few suggestions to help keep you on track and avoid falling prey to this nasty deceiver called recency bias-
1) Gain a deep understanding of your financial situation from an asset and liabilities point of view. Understand where you stand and what your monthly inflow is after adjusting for all the loans and EMIs which you are paying for
2) List down your financial goals for the next 10, 20 and 30 years and work backwards to identify what percentage of your net income do you need to invest to achieve those goals. You can use any of the financial calculators available online to analyse this
3) Systematically invest your savings across different types of financial instruments like equity, debt and gold (ETFs included) based on your risk tolerance. As a thumb rule, the more equity in your portfolio, the more riskier it is
4) Stick to investing regularly and slowly increase the percentage of income you invest; When the new iPhone 13 comes out, don’t reduce your investments to buy it, rather reduce your expenses to make that esteemed purchase :)
Keeping recency bias outside of our investing decisions is a task, but not unachievable. You should make investments based on our predicted needs in the future, choose instruments based on your risk tolerance and make periodic investments over time. This habit of systematic investing is what will give you the most desirable outcomes and help you in the long run.
The next time you are enticed by buying the hot stock which will make you rich, stop and give that thought a gnarly stare, because that stare is what will actually make you wealthy.
Always be Aanya, not Vihaan.
Author: Team dezerv.
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