The Value of Staying Invested
When it comes to managing our investments and wealth, we can be our own worst enemies. Behavioral finance research has revealed how emotional and cognitive biases can lead investors to make financial decisions that harm rather than benefit them. From panic selling during market downturns to overconfidence in bull markets, ingrained behavioral patterns frequently result in inappropriate asset allocation, poor market timing, and reduced long-term returns.
This is especially relevant as we enter 2025. With the stock market and many other asset classes near all-time highs after two years of strong returns, understanding these biases is more important than ever. They are also the first step in developing a more disciplined and rational approach to investing.
Recency bias results in short-term thinking
Recency bias, or focusing too much on recent events rather than long-term patterns, can lead investors to make bad decisions. Market gains over 2024 are a perfect example of the perils of letting short-term concerns drive long-term investment decisions. Despite many concerns around a recession, the Fed, the presidential election, geopolitical conflicts, and the general fear of volatility, the S&P 500 has had a great year. This highlights how markets can climb a “wall of worry” even during challenging times.
As this chart above shows, investors who did not stay invested in an appropriate portfolio during the 2008 financial crisis most likely derailed their financial plans.
Those who switched to cash for extended periods missed out the most, but even investors who did so for only one year at the market bottom in March 2009 ended up significantly worse off than those who stayed fully invested despite the significant market swings.
While we’re focusing on the 2008 financial crisis in this example, the same is even more true for the 2000 dot-com crash, the 2020 pandemic bear market, the 2022 pullback, or any other period of market turmoil.
Recency bias can cause investors to put too much emphasis on recent market events while undervaluing longer-term patterns. This can mean pulling money out of the market after a crash or over-allocating to stocks when they are doing well, at the expense of portfolio balance. While it’s normal to feel concerned during periods of uncertainty, emotional reactions to market movements tend to lead to poorly timed investment choices and missing out on long-term gains.