E Recency Bias And Wrong Thinking

“Invert, always invert!”

--Charlie Munger, Vice-Chairman of Berkshire Hathaway

It’s rained like crazy for months; the drought is gone for good. The economy is growing and will continue to grow, so credit and consumption expand. Housing prices are rising, they will always increase—buy a house anywhere at any price now.  The bull market’s lasted six years, it will keep on stampeding, so invest more today!

People project not only good times but also bad times into the future. The war, drought, or recession will never end. Crushed stocks will go to zero. Sell now!

This human behavioral tendency is recency bias. We think whatever is recent will continue. It can, but not indefinitely. The longer something continues, the more likely it is to change. When I was younger, the Democrats controlled both houses of Congress for what seemed like forever. Then it changed. Just as it seemed inconceivable to have a Republican House of Representatives, now it seems unimaginable to have a Democratic one.

AT&T monopolized the telephone industry. It was the only choice. AT&T owned the wires to your home and the equipment you used. Heck, the Princess phone was a revolution, let alone push button dialing! You couldn’t legally attach any equipment to your phone, not even an answering machine. Then poof! A judicial order ended the monopoly in the early 1980s and largely unleashed the telecom revolution of widespread mobile and Internet communications.

Recency bias causes poor investing decisions. The progression of stock markets is mania, panic, crash, and recovery to mania, panic and crash again. This is called a market cycle. Few pay attention long enough to see even one full market cycle. Rather, they say the current condition as all there is. This is why investors tend to buy high at times of great enthusiasm—mania—and sell out at times of fear—panic and crash. A sad flaw of dollar-cost averaging, the alleged remedy requiring investing on a regular basis, is that people tend to stop (or move to cash) in panics and resume (or move to stocks) in manias. This loses money permanently.

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Tom Jacobs is an Investment Advisor for separately managed accounts with Dallas’s Echelon Investment Management. You may reach him at more

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