The Dangers of Recency Bias

‍My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.

⸺Warren Buffet

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Even the world’s greatest investors have succumbed to our tendency to favour recent events over historic ones, also known as recency bias. This behaviour often influences others to do the same, as we are only human, after all. 

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When I first starting using X (formally Twitter) over 10 years ago, I would see a tweet and think it was always my job to correct people.

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Many years later, I just take screenshots of all these mistakes and use them as tools to support Barnaby Cecil's clients. It’s a smarter and way more efficient use of my time.

A classic example is how we think about the S&P 500 (Standard & Poors). The S&P is one of five major US indices, alongside the Dow Jones, Russell 3000, Nasdaq and the New York Stock Exchange. 

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The idea with these indices is that you need not bother with all the other US stock markets (which list fantastic companies like Gillett, Nike and Google) because you can just hold one index. 

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If you look at data from the last decade, the S&P 500 indeed seems like the place to be. If you invested in the S&P 500 ten years ago, your investment would have grown by 316%. 

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But what about the decade before that? 

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Looking at data from the last two decades, you’ll find that specific segments of the global market, such as the S&P 500, haven’t always fared so well. In fact, at the start of this century (circa 2000), the S&P 500  dramatically underperformed every other market within the overall global market. 

By focusing solely on recent returns, as the chart illustrates, modern investors might be suffering from a potentially detrimental investment bias.

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We see this with investors who follow popular advice from Buffet or ‘The Finance Guy’ and select the best-performing US index. By acting on short-term data, they miss out on the greatest strength of the overall US market⸺its breadth and depth. 

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The US market is incredibly diverse, drawing in some of the best talent in global CEOs and ideas, unlike the UK stock market, which hasn’t changed much in a hundred years.

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But can you improve upon the US market alone? It’s certainly not a bad place to start. I wouldn’t lose much sleep if a family member told me they exclusively held a US Equity index fund. 

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However, as the final chart shows, by investing outside the US or UK and into the global stock market you can also capture great companies in Germany, Japan, India and beyond. 

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While your investments are in smaller percentages, it is the collective strength that drives returns. 

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Past performance is not an absolute guarantee of superior performance or, as our legal team will remind me, any performance at all. But when you use over a century of data to back-test your investment philosophy, it’s not a bad place to start. 

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To ensure we don't become victims of any cognitive bias ourselves, we employed Timeline in 2019, a team of independent investment consultants, to challenge our philosophy and ensure our strategies are back by academic rigour.

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By diversifying beyond recent trends and single markets, we can harness the collective strength of global opportunities, ensuring a more balanced and resilient investment strategy.