Editorial / Personal Finance & Investment

Recency Bias: How Zooming-Out Can Help You Make Better Investment Decisions  

A taxi drops you off at the 10km mark of Sydney’s famous City2Surf fun run, presenting you with the final 4km stretch of the race, being largely downhill.

With the sea breeze welcoming you as you jog down the winding hills to Bondi Beach, and having no prior knowledge of the course, you could be excused for being ignorant of the arduous “Heartbreak Hill” that other runners had ascended to reach the halfway mark of the 14km race. 

Your perspective of the whole is skewed by the point-in-time at which you establish your view. 

In a similar vein, there are certain managed investment funds whose returns have dropped by 30-60% over the past year. 

Entering the market recently, you might look at these funds and take quite a negative view of their performance. If you were purely judging them over a one-year period, then you would be well-entitled to that conclusion. 

However, if you were to go back to a range of different points-in-time, you would likely determine the outcomes much more favourably.  

A prime example being pre-covid, assessing the 1, 3, 5, 7, and 10-year performance. The numbers are suddenly exponentially better.

Macro-conditions have shifted dramatically, causing certain sectors of the market to re-rate and de-value considerably. The businesses themselves continue to be of high quality, however the external conditions playing upon them were strong enough to create panic. 

Here lies the opportunity. 

At some point in the future, conditions will normalise. In this period of reset, great companies will restructure their businesses, cut out futile projects and excess staff, increase margins, become more effective and efficient, and be ready for the next cycle of growth. 

We need to remember that some of these companies – well-known behemoths like Tesla, Microsoft, Alphabet, Workday, and ServiceNow – are the best allocators of capital (both human and financial) in the world.  They know how to create value, drive profits and deliver to shareholders.  

This point about being the best allocators of capital in the world, should not be taken lightly. These companies have created hundreds of billions of dollars of economic value. A feat of this scale cannot be taken for granted when assessing quality investment targets. 

A reset in the economy might change their share price at a point-in-time, but it does not change the quality of the underlying business.  

On the contrary, we must realise that every day in stock markets across the world, people are joining the race with 4km to go. Their breeze-assisted view is skewed by recency bias and failure to zoom out on the broader picture. 

What characteristics do we need to take advantage of the current situation at this point-in-time in the economy? 

  1. Courage – to step out of our comfort zone and invest contrary to the current market sentiment. 
  1. Ongoing Analysis – to take out perspective beyond the current point-in-time, we need to make analysis an ongoing exercise.  
  1. Patience – to sit tight through the periods where the market is not yet turning in our favour. 

Creating compounding wealth does not come about through short-sighted, rash decisions. It requires the attributes outlined above, coupled with the inherent discipline to trust the process.