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Avoiding Mistakes (Part 2)

Mistake #2: Recency Bias; Mistake #3: Paying Too Much Attention

Ben Johnson 22.01.2018

In part 1 of this article, I talked about the first common mistake in investing – “Trying to Control Things You Can’t”. In this part of the article, I will go through the other two common mistakes.

Mistake #2: Recency Bias
Recency bias describes our tendency to extrapolate our recent experience into the future. When my three-year old throws a tantrum, I tend to picture her as a grown woman kicking and screaming on the floor, even though I’m confident she’ll become a well-adjusted adult. Investors do the same. Stocks have been marching higher for the better part of a decade, so surely they’ll only continue to climb...right?

Recency bias can become particularly dangerous in bear markets. Falling stock prices can lead to panic selling, and shell-shocked investors can be slow to get back in once markets rebound. There’s plenty of evidence that the psychological effects of the global financial crisis linger with investors to this day, as many of them have remained on the sidelines for much of the ensuing recovery. Remember, whether or not you are invested is the most painfully obvious determinant of your outcomes. Sitting out on a nearly decade-long rally has been a serious setback for many.

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About Author

Ben Johnson  Ben Johnson, CFA is the Director of Passive Fund Research with Morningstar.

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