Don't time the market, tame the recency bias: Experts

With India’s Covid-19 cases climbing almost vertically, the stock markets have not seen a vertical decline during the second wave. Experts believe that unlike last year, the markets are range-bound today because of a logic-based correction, not a fear-based one. Investors waiting for a buying opportunity like last year may not find one. Staying invested without recency bias creeping in will help create wealth.

“Don’t get swayed by recent events. Stay invested in equity or debt as per your own pre-decided asset allocation and don’t change it because of market movement,” said Feroze Azeez, Deputy CEO, Anand Rathi Private Wealth. “Recency bias should not come in,” he added.

What is recency bias?

Imagine this – ‘when Covid-19 cases rise, markets fall.’ Or, ‘when cases start rising, gold prices shoot up.’

These are biases and not investment doctrines. They were true in 2020, not today.

But these biases arise because of a recently visible pattern (2020), not reasons for that pattern (Covid-19 being an unknown variable in 2020).

According to Vishal Dhawan, Founder & CEO, Plan Ahead Wealth Advisors, “As humans, we are constantly looking for patterns that repeat themselves and when it is in the recent past, we tend to remember these patterns more closely. Therefore, it is critical to understand the triggers behind the pattern rather than the pattern itself before taking any action on the same.”

Unbiased asset allocation

Asset allocation between equity, debt and gold should be made with a future goal in mind, not the recent-past trend in either investment category.

“Buying when an asset is cheap and selling when an asset is expensive is one of the best ways for investors to generate long term wealth. However, very often, a recency bias can prevent this from happening and impede long term goals as investors go overweight in an asset class that is very expensive and sometimes also use leverage with the same, which can cause even more damage if the wrong asset class is invested in at the wrong time,” said Dhawan.

In the present market context, Azeez said, “If you wait for markets to fall to buy equity, a buying opportunity as deep-rooted as last year will not come. If you have less than 50% equity in your portfolio, scale up, irrespective of present prices,” before adding that timing the markets is seldom possible.

“Having a strategic asset allocation with a smaller tactical range works well for most investors when they have a recency bias emerging from the fact that they were unable to time markets perfectly in the recent past,” said Dhawan.

Avoid recency bias mistakes

With investors having done much better investing in equities than in debt in the last year, there is a risk of going overweight on equities instead of rebalancing by moving from equity to debt this year. That, according to Dhawan, is a risk to the portfolio.

“This is also true with gold at this point as the recent returns of gold as an asset class are lower, and thus investors are likely to go underweight on gold as well, even though equities may be richly valued,” he said.