Stock Market · Mind over Markets

Recency bias

Recency bias is the brain's tendency to overweight recent events when forecasting the future. The latest headline feels more important than 10 years of pattern. The last 3 months of returns feel more predictive than the last 15 years.

How it shows up in investing

1. Chasing hot funds: 'This fund returned 40% last year, I'll invest now!'

2. Avoiding underperformers: 'This sector has been flat for 2 years, skip it'

3. Panicking in crashes: 'Markets just fell 15%. They'll fall another 30% surely'

4. Euphoria in rallies: 'Markets just rose 20%. They'll double next year'

The Indian retail pattern

SIP inflows surge AFTER market rallies and slow AFTER crashes. The opposite of optimal.

March 2020 (Nifty 7,500): SIP inflows fell sharply. Retail capitulated.

January 2025 (Nifty 24,000+): SIP inflows at record highs. Retail buying euphoria.

Buy high, sell low. Recency bias in action.

The thematic fund trap

Recency bias makes thematic funds especially dangerous:

• 2017-2018: Small caps were hot. Small cap fund inflows peaked. Then small caps crashed 30% in 2018-2019.
• 2020-2021: Pharma funds were hot post-COVID. Inflows peaked. Then pharma underperformed for 2 years.
• 2023-2024: Defence and manufacturing themes hot. Inflows peaked. Future returns uncertain.

> The fund that was up 50% last year almost never repeats. Recency bias hides this from investors.

Defeating recency bias

1. Use LONG-TERM data (10+ years) for any forecast

2. Rebalance mechanically to your target allocation. This forces you to sell recent winners and buy recent losers

3. Don't make major allocation changes based on 6-12 months of returns

4. Read about prior market cycles. Markets repeatedly do things that feel impossible in the moment

The 200-year frame

Over 200 years of US equity data, the worst 10-year periods returned about -1% annually. The best 10-year periods returned 17%. Equity always returned positive over 30-year windows.

Whatever you're feeling about the current market. It's likely overweighted to the last 12 months.

Takeaway. Recency bias overweights latest events vs long-term patterns. Causes chasing hot funds and panicking in crashes. Use 10+ year data for forecasts. Mechanical rebalancing forces you to sell winners and buy losers. The discipline recency bias destroys.