The Finanacial Turmoil and Recency Effect

Since we are in the midst of a recession, and anyone denying it is really hanging on to technicalities, it’s easy to fall into the recency bias trap. The recency effect, which is a term borrowed from the psychology discipline, refers to the tendency of people to remember recent events more vividly and give them a higher consideration than historical information. Unfortunately the recency bias could result in the abandoning of logical thinking when it comes to long-term financial strategies.

Here are some examples of the recency bias when it comes to investing:

* Deciding to keep money at home( in the mattress, a safe, etc’) as opposed to depositing it in the bank and letting it earn interest.

* You decide to transfer your money into “better” investments, such as bonds and gold

* You decide to cash out of your retirement savings.

Whenever a person makes this type of decision, they are allowing recent event to directly affect their long-term planning to the point of abandoning what was once considered a sound strategy. Although, you may be right in changing your approach, this is highly unlikely.

The following are the likely results:

* Your bank doesn’t declare bankruptcy and you missed out on the interest while your money was at home.

* The stock exchange begins to recover and in the meantime bonds and gold start declining. You then move your money back into stocks which leaves you paying more in the end.

* You pay taxes and penalty fees for early withdrawal from your retirement account. Stocks recover and you are left behind on gains you could have made.

Allowing news and events to drive your strategy is never a recommended. Instead, you should come up with a strategy that will withstand both the highs and lows of the market. For example:

* Select the right asset management that is right for your time horizon and risk tolerance threshold

* Regularly contribute money to your portfolio

* Reanalyze and balance your portfolio annually

The only time to actually move out of the financial market is if your individual stocks are showing obvious signs of crashing beyond repair.

Having knee jerk reactions to financial news is not a wise decision. History, we have to remember, is a good teacher of this.