Federal employees and retirees investing in the Thrift Savings Plan (TSP) could find that their retirement savings get derailed in part due to recency bias, a phenomenon that tends to creep into peoples’ investment behavior.
If you live in cold weather state like my home in Michigan, you’re probably familiar with the following scenario. Let’s imagine we have a winter where we suffer through record snowfall and your two-wheel drive sedan gets stuck routinely on the way to work. Life is miserable.
The following year, you resolve to “not get fooled again.” When your lease is due, rather than the same old sedan, you splurge on the four-wheel drive SUV complete with the super arctic trim package and ski rack. It doesn’t matter if you don’t ski. You want to be prepared.
Once you buy the SUV, it seems to stops snowing. The following year we have record low snowfall. You shovel once or twice and you even have to remind yourself how to turn on the four-wheel drive on the rare occasion you need it. Come spring, you lament your $750 car payment and the poor fuel economy.
At least you have the ski rack; the next owner will really enjoy it.
If this has ever been you don’t feel bad. You have just experienced recency bias. We all have it.
What is Recency Bias?
Recency bias is the tendency to place too much emphasis on experiences that are freshest in your memory—even if they are not the most relevant or reliable. We display recency bias when we make decisions based on recent events, expecting that those events will continue into the future.
For example, right now with gas hovering over $4.00 a gallon, how many of you are thinking of going with an electric vehicle in the future? I don’t know the answer, but I’m sure a few more of you now than two months ago.
Recency bias is found everywhere but especially in sports and investing. In Detroit, we love sports. We love talking about sports. On the local sports radio station, fans and “experts” make predictions on our local teams based on the most recent outcome. If we win, then the future looks bright. Lose the night before, we want to fire the coach. We ALWAYS want to fire the coach. If you don’t believe me, tune in to sports talk radio on Monday morning.
Let’s take our favorite punching bag in Michigan: the Detroit Lions. A year ago, we had a quarterback by the name of Matthew Stafford. He is now known as “Super Bowl Winning Quarterback” Matthew Stafford. He plays for LA. Lucky guy.
Before he left Detroit, he was a bad quarterback. He was called an underachiever, a stat hog, and a poor leader. He had exactly ZERO playoff wins.
Now, he is a top 5 quarterback, a come from behind hero, a Super Bowl champion and a possible future hall of famer.
What a difference a year makes.
Stafford is the same guy as he was a year ago, even with the super bowl win. It’s our perception of him that has changed because on his recent success. We conveniently forget the fact that he is 33 years old and has 13 NFL seasons. One season made the difference.
Applying Recency Bias to Investing
In the investing world, recency bias can be hard to avoid. TSP participants display this bias when they make decisions based what’s happening now, good or bad, expecting the current state to continue long into the future. It can lead them to make irrational decisions, such as following a hot investment trend or selling securities during a market downturn. When things are going well, money pours into the C Fund. When it’s poor, it floods into the G Fund.
Right now, we are in the midst of a major market pull back. The Russian invasion of the Ukraine has shaken already nervous markets. Things look bad.
What do you do at a time like this? Do you move into the G Fund and ride it out? Many of you are tempted right now to do so.
Sadly, the TSP makes it easy for you. You get 2 interfund transfers per month. However, if you want to abandon your investment strategy and go to the G Fund, you can do this as many times as you want. Transfers into the G Fund are unlimited. Thank you, TSP.
How Do I Beat Recency Bias?
It helps to take a look at the broader picture. For example, a little less than two years ago, gas prices were hovering around $1.00 a gallon. Heck, the price for oil went negative one month! Now oil is as high a Stafford’s popularity. Will the present state remain the same? Will the former Lions loser repeat as a champion? Will gas stay at $5.00 a gallon?
History says no. Sorry Stafford fans, oil, like the Rams QB, will eventually fall back to earth.
If you are getting really nervous, something as simple as taking a deep breath works. Emotions are the enemy of reason. Nothing stokes the fire nowadays quite like the media so try and take a media diet. Personally, I haven’t been able to take my eyes off the set since the invasion began. Like you, my family and I are praying for peaceful outcome.
But…and this is a big BUT, I don’t make investment decisions from what I see on CNBC, CNN or Fox News. I haven’t altered my portfolio one bit since Russia invaded.
What gives me the confidence to stay the course?
I think the quote below from March of 2020 says it all.
“If markets are good at one thing, it’s reminding investors that stock prices don’t simply go up, uninterrupted, forever. Markets decline. It’s an unavoidable part of investing. What matters is how you respond. Or, more to the point, how you don’t respond in some cases.
Because if you’ve built a portfolio that matches your time horizon and risk tolerance when markets are calm, then a surge in turbulence may not feel so devastating; especially if you have adopted discipline around diversification and regular rebalancing.”Panic is not an Investment Strategy. March 10, 2020, Liz Ann Sonders
The Dow Jones Industrial Average dipped below 19,000 at one point when this article above was published. The DJIA remains over 32,000, even now.
What if we had used the “present” in March of 2020 as our map for decisions about the future. How well do you think that would have worked out? Do you see the danger in recency bias?
So, don’t make that same mistake now. Don’t let recency bias derail your carefully crafted Federal retirement investment plan.
We have a saying in Michigan. If you don’t like the weather, just wait 15 minutes, it will change.
Not every winter will have record snow fall. Gas won’t be $5.00/gallon forever. Stafford won’t win the Super Bowl every year. The market will eventually rebound.
Keep your cool and you’ll come out ahead.
Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC. LPL Financial and its representatives, Mission Point Planning and Retirement do not provide tax or estate planning advice. These are services are provided in conjunction with a qualified tax and/or estate planning professional.
The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.