Recency bias is the tendency to overweight recent events when making predictions about the future, assuming current conditions will continue indefinitely. It's the reason bull markets breed euphoria and bear markets breed despair — and why both are often overdone.
The 2021 Bubble Example
In 2021, after a decade of tech dominance and pandemic-accelerated digital trends, growth stocks seemed unstoppable. The Nasdaq had returned 20%+ annually for years. Recency bias made that feel permanent. Investors flooded into high-growth, unprofitable tech companies. ARK Innovation ETF (ARKK) attracted hundreds of billions, betting that recent trends would continue forever.
But 2021 wasn't "the new normal." The S&P 500 has cycles. The 2010s were exceptional — a decade of nearly uninterrupted bull market gains driven by zero interest rates and quantitative easing. That decade wasn't representative of typical market behavior.
When 2022 arrived with rising rates and inflation, the entire narrative flipped. Tech crashed. The same investors who bought at the peak in November 2021 panic-sold in March 2022 — a perfectly recency-biased sequence. They extrapolated 2021's trends forward (wrong) and then extrapolated 2022's decline indefinitely (also wrong).
Historical Patterns
Historically, when the S&P 500 has returned 20%+ annually for 2+ consecutive years, the subsequent 3-year returns have averaged 7-8% — roughly half the recent pace. This is predictable mean reversion, not a surprise. Yet every bull market feels like it will continue forever, and every bear market feels permanent.
The Investing Consequence
Recency bias drives the worst market timing decisions: buying after large gains and selling after large declines. The average investor underperforms the market by 3-4% annually, primarily because of recency-driven market-timing mistakes.
If you invested in an S&P 500 index fund at the market's peak in 2007, your 15-year annualized return would be roughly 9% — not bad, despite timing terribly. But the average investor who bought high and sold low after 2008 earned far less.
Overcoming It
Systematic approaches fight recency bias. Rebalancing forces you to sell what's performed well and buy what's underperformed — the opposite of what recency bias recommends. A rule like "I will never change my asset allocation because of recent performance" removes emotional decision-making.
