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In a recent episode of Intelligent Money Minute, we had the pleasure of interviewing Larry Swedroe, the head of Financial and Economic Research at Buckingham Strategic Wealth. Our discussion centered around the dangers of recency bias, a common emotional tendency among investors. Larry emphasized the importance of understanding historical context and avoiding the trap of projecting recent events onto the future. In this blog post, we’ll share some key takeaways from our conversation and explore strategies to overcome recency bias in investment decision-making.

Recognizing Recency Bias

Recency bias refers to the tendency of investors to give excessive weight to recent market events when making investment decisions. We have a natural inclination to believe that what has just occurred will continue in the short term. This bias often leads us to ignore historical data and overlook the importance of long-term correlations. Larry stressed the need to become students of history and cautioned against relying solely on recent trends to guide our investment choices.

Larry highlighted that recency bias is one of the most detrimental mistakes investors can make. While there is evidence of short-term momentum, where recent winners tend to continue performing well for a limited period, it’s crucial to remember that trees don’t grow to the sky. Valuations can reach unsustainable levels, driven by investor enthusiasm. Larry cited examples like the dot-com era and the recent market bubble, where unprofitable companies achieved sky-high valuations based on recent success. However, high valuations eventually come back to haunt investors. To avoid this pitfall, he emphasized the importance of sticking to your investment plan and not being swayed by recency bias.

Strategies to Mitigate Recency Bias

To counteract the influence of recency bias, we discussed several strategies during the interview. One effective approach is disciplined portfolio rebalancing. By selling some of the high-priced winners and buying assets that have performed poorly but offer higher expected returns, investors can maintain a balanced portfolio and avoid chasing recent winners. Additionally, we explored the role of trend following, specifically managed futures, as an investment class that captures short-term momentum swings. However, it’s crucial not to allocate all your assets to trend following, as it can underperform for extended periods. Larry recommended considering a 5% to 10% allocation to mitigate tail risk during prolonged bear markets.

Recency bias can be difficult to overcome alone, especially during times of market volatility. That’s why having a financial accountability partner is vital. This partner can help design a financial plan and keep you grounded when fear and greed tempt you to deviate from your investment strategy. At our firm, we provide clients with proprietary interrogations that guide their decision-making and minimize financial stress. We believe in the power of having someone who holds you accountable and helps you stay on track to achieve your financial goals.

Recency bias is a common pitfall that can hinder investment success. By recognizing the bias and incorporating strategies like disciplined rebalancing and selective trend following, investors can overcome this challenge. Moreover, having a financial accountability partner can provide valuable guidance and prevent emotional decision-making. Remember, it’s essential to view investment decisions through a historical lens and remain committed to your long-term investment plan. By doing so, you can minimize the impact of recency bias and maximize your chances of achieving financial success.

We’ll be interviewing Larry on several podcasts regarding markets, passive investing, and diversification, so be sure to subscribe to our Intelligent Money Minute podcasts.

Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has since authored seven more books.

Larry Swedroe Bio

Since joining Buckingham Strategic Wealth in 1996, Chief Research Officer Larry Swedroe has spent his time and energy educating investors on the benefits of evidence-based investing.

In his role as chief research officer and as a member of the firm’s Investment Policy Committee and Board of Directors, Larry regularly reviews the findings published in dozens of peer-reviewed financial journals, evaluates the outcomes and uses the result to inform the firm’s formal investment strategy recommendations.

Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television shows airing on NBC, CNBC, CNN and Bloomberg Personal Finance. Larry is a prolific writer, contributing regularly to multiple outlets, including Advisor Perspectives and ETF.com.

Before joining Buckingham, Larry was vice chairman of Prudential Home Mortgage and senior vice president at Citicorp.

Larry holds an MBA in finance and investment from NYU and a bachelor’s degree in finance from Baruch College.

Credits: This blog was written in part by ChatGPT, an AI language model developed by OpenAI. The content of this blog reflects the knowledge and opinions of ChatGPT, may or may not reflect the knowledge and opinions of Intelligent Investing, and is protected by copyright laws. Please do not reproduce or distribute without giving proper credit to ChatGPT and OpenAI.

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Traditional diversification failed in 2022, but why did it happen, and will it happen again? On this episode of Intelligent Money Minute, Hans Blake interviews Larry Swedroe, the head of economic and financial research at Buckingham Wealth Partners, who also co-authored 18 books. According to Swedroe, traditional diversification, which was within the 60/40 stock and bond allocation, failed in 2022. Both stocks and safe treasuries had double-digit losses, which is the first time this has happened, making it almost the worst year for a 60/40 portfolio. Moreover, longer-term treasuries lost over 20%, and the S&P was down by about 18%. Correlation between these two risk assets has been negative for the last 20 years. However, if you look at the last hundred years, the correlation was positive at about 0.2. Therefore, traditional diversification failed because correlations between stocks and safe bonds are time-varying.

Swedroe emphasizes that investors shouldn’t treat correlations as a permanent number, as they are time-varying. He explains that correlations do not mean that when one asset goes up, the other goes down. It means that when one has a better-than-average return, the other one has a worse-than-average return. During the last 20 years, we had a negative correlation between stocks and safe bonds, so investors thought that when stocks got crushed, bonds would tend to do better than their average. However, that didn’t happen in 2022, making investors rely solely on safe bonds and equity bonds, which could be risky.

Swedroe recommends that investors consider including other non-traditional assets that will do well in such periods. For instance, reinsurance, private floating debt, long-short equity, private real estate, and other alternatives can help dampen the risk in an investor’s portfolio. He mentioned that last year, all of the alternatives he owned were up, which helped diversify his portfolio. He advises investors to consider adding other unique sources of risk to their portfolio and not rely solely on safe bonds and equity bonds. Lastly, he says that investors must have a diversified portfolio to help mitigate these unusual time periods when correlations of traditional assets rise.

We’ll be interviewing Larry on several podcasts regarding markets, passive investing, and diversification, so be sure to subscribe to our Intelligent Money Minute podcasts.

Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has since authored seven more books.

Larry Swedroe Bio

Since joining Buckingham Strategic Wealth in 1996, Chief Research Officer Larry Swedroe has spent his time and energy educating investors on the benefits of evidence-based investing.

In his role as chief research officer and as a member of the firm’s Investment Policy Committee and Board of Directors, Larry regularly reviews the findings published in dozens of peer-reviewed financial journals, evaluates the outcomes and uses the result to inform the firm’s formal investment strategy recommendations.

Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television shows airing on NBC, CNBC, CNN and Bloomberg Personal Finance. Larry is a prolific writer, contributing regularly to multiple outlets, including Advisor Perspectives and ETF.com.

Before joining Buckingham, Larry was vice chairman of Prudential Home Mortgage and senior vice president at Citicorp.

Larry holds an MBA in finance and investment from NYU and a bachelor’s degree in finance from Baruch College.

Credits: This blog was written in part by ChatGPT, an AI language model developed by OpenAI. The content of this blog reflects the knowledge and opinions of ChatGPT, may or may not reflect the knowledge and opinions of Intelligent Investing, and is protected by copyright laws. Please do not reproduce or distribute without giving proper credit to ChatGPT and OpenAI.