Recency-driven behavior vs historical reality
| Recent Event | Recency-Driven Behavior | Historical Reality |
|---|---|---|
| 3-year bull market | Increase equity allocation, add leverage | Long bull markets increase reversion risk |
| Market crash | Sell everything, go to cash | Stocks historically recover within 2–3 years |
| Sector outperformance | Pile into the hot sector | Sector rotation means today’s leader is often tomorrow’s laggard |
| Low volatility | Reduce hedges, sell insurance | Low vol periods often precede vol spikes |
Why retail flows tend to peak at market tops
Recency bias explains why retail inflows peak at market tops and outflows peak at market bottoms. Investors extrapolate the recent past into the future, which is exactly wrong at turning points.
See recency bias in fund flow data
Check fund flow data — when did retail investors put the most money into equity funds? It’s almost always after a strong rally. When did they pull the most? After a crash. This is recency bias at the aggregate level.
Is abandoning stocks after flat years a bias?
The market has been flat for 3 years. Your friend says ‘stocks don’t go up anymore — I’m moving to bonds.’ What bias is at work?
Why base rates beat recent memory
Check your understanding
Sit with the ideas.
After 2022's bear market (-20%), only 20% of retail investors expected positive returns in 2023. The S&P 500 then returned +26% in 2023. What does this pattern most clearly illustrate?
Why: