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A podcast designed to help retirees and those nearing retirement navigate finances and life planning with expert insights from financial advisor Trevor Lawson. Tune in for practical strategies and inspiring ideas to ensure your retirement years are purposeful, fulfilling, and truly your best chapter yet.
*Securities and investment advisory services offered through Osaic Wealth, Inc. member FINRA/SIPC. Osaic Wealth is separately owned and other entities and/or marketing names, products or services referenced here are independent of Osaic Wealth. Branch phone: 919-546-0400.
Welcome to The Retirement With and On Purpose Podcast. I'm your host, Trevor Lawson, and this show is all about helping you not just reach retirement. But truly thrive in it. You've put in the work. Now let's make sure you can enjoy every moment to the fullest.
Today's episode is about another very powerful cognitive bias, and we're gonna stick to one today because we're gonna get kind of in the weeds with it. It is recency bias and so again, one of our investment partners, Charles Schwab, has published a, a great. Article and video that I'll share in the show notes on recency bias.
They define it and talk about ways to protect against it. And we're gonna talk through some of those items today. And for you, the listener, to take a deeper dive, feel welcome to check out the [00:01:00] show notes and, and, and take a peek at the video. But recency bias is, again, another cognitive bias that.
Significantly impacts our financial decisions. And I'll run through a couple examples just so you can perhaps see how relevant these are to, to both you and I and our, our line of thinking. So first and foremost, 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.
The example, uh, the author here uses, would you want to go for a long ocean swim after watching Jaws? Probably not. Let's think about some other pertinent examples to investing. So one very, very, very popular one right now is mortgage rates. So if we zoom out the average 30 year. [00:02:00] Mortgage rates since 1971 is close to 7.5%, give or take.
However, recency bias makes it feel like current rates are ex astronomically high. Because we're coming off of historically low interest rates around three or 4%, so this reversion back to a very normal interest rate fills. Very abnormal and, and very high. And it's keeping a lot of folks from acting on purchasing a new home or even considering buying to begin with.
And what's striving that is this cognitive bias, recency bias. Another example is investing in a sector based on its recent high returns. So I can't tell you how many clients over the past two or three years because the large cap sector, you know, driven by the s and p 500, the 500 largest US companies has been on fire, I mean, has been on absolute fire.
And so [00:03:00] more and more clients are thinking it's a good idea to just put most, if not all, of their investment portfolio in the large cap sector. Driven by recency bias and how well it's done over the past two years. But if we zoom out and we look back 10, 15, 20 years, we'll see that real estate, the small cap sector international have had years where they've significantly outperformed the large cap sector.
So I'll talk more about how to combat recency bias in a minute, but that just kind of is a little teaser along the way. So what do we do with recency bias and, and why does it even matter to begin with? So consider I'm quoting here. Consider the cost of chasing hot investment trends in 2021. Real estate was one of the best performing sectors in the s and p 500 index, delivering an annual return of a whopping 46%.
A client who [00:04:00] subsequently loaded up on real estate stocks may have been s severely disappointed as that sector returned negative. 26% in 2022. So one year later it was down negative 26%. However, if we let recency bias creep in and think, hey, real estate is, is on a tear, it's a good idea. You know, based on how it did last year for us to load up on it this year, well that proved not to be the case, and we would've given back a lot of those gains we saw the year prior.
So what can we as investors do about it? Several things and several things that we talked about on the last podcast to combat those cognitive biases, you know, anchoring bias, loss aversion bias, those same tactics can be applied here. Implement a long term investment strategy. So I talked about just a second ago how when you look at the large cap sector, yes it's done phenomenally well the past two years.
But if you zoom out and [00:05:00] look back further, there's other sectors of the market that have have done much better than the large cap sector, depending on the particular year that we're looking at. Diversify, diversify, diversify. Again, it just, it, if we, if we develop a diversified portfolio that works for us, it takes a lot of the tendency to wanna, in the earlier example, move into real estate after it's had a very good year or move into the large cap sector if it's had a good year.
Maintaining a diversified position really helps counterbalance that. Tennessee a, a very important one that oftentimes goes overlooked, particularly. 4 0 1 Ks. So most, most clients during their working years, they're the, the main place they're saving right now is in their 401k offered by their employer.
But if you don't activate or don't go in there and do it yourself, the rebalance feature, what happens is in years you may start with a diversified portfolio. So you've got, you know, some large cap US [00:06:00] stocks, you've got. International, maybe you've got some fixed income. You've, you've got a, a very diversified portfolio.
But if you personally, or thankfully, most 401k providers now offer this rebalance feature. If you don't activate that, what's, what happens is during years, like the past two years, the large cap sector has done phenomenally well, and so as a result, that part of your portfolio becomes a much bigger dollar value.
In turn becomes a higher percentage of your overall portfolio's value making your, your, your portfolio way outta whack and no longer diversified because you've got much more percentage wise in this large cap sector that's done, done well as of late. So that's one, one thing I'd encourage. Folks to consider is rebalancing their portfolio, whether they do it themselves, which I tend to advise against.
I would just activate the rebalancing feature inside of your 401k [00:07:00] portfolio if you can, and or delegate the responsibility of the management altogether to your investment professional, and that's something they should be doing proactively for you. Review historical data. So again, I, I referenced this chart multiple times now, but if you look at different asset classes over the past 50 years, you'll see how different sectors have performed over time, and you'll see that there's been years where one particular sector has done very well and years where it has not done so well.
So review historical data to help guide your decision. I know that's a lot, and again, a lot of those same tactics are applicable to other cognitive biases. But as I mentioned last time, my, my hope over these episodes of talking about different cognitive biases are just to make you the investor aware of how pertinent they are, particularly during times.
Market volatility where it can be very easy for us to perhaps get our own way by letting these cognitive [00:08:00] biases drive our investment decisions. So my hope is just to make you aware and therefore empower you to be better equipped to recognize it and combat it next time your presented with one of these cognitive biases.
That's it for today. I hope you found this helpful, and I'll look forward to being with you again soon. Take care.