How recency bias makes us forget about history
Mitchell Barr, Client Associate
As I was relaxing poolside on July 4th shoveling my face with hot dogs and potato salad, my lovely grandmother, who is always looking out for me, asked about work. I told her I was starting a blog about drunken monkeys in people’s heads that cause them to make bad financial decisions (She is very proud). This led to an interesting discussion with my grandparents about how much money one needs in order to retire. My grandfather leaned in and looked over his glasses like old men do when they are making an important point and said, “When we retired seventeen years ago, we were told we would make 8 percent a year in a money market fund, no problem.”
Hearing that in today’s interest rate environment, it sounds like an absurd assumption that no one would ever believe. If this magical fund did exist, every retiree in the country would be jumping up and down like teenage girls at an Ed Sheeran concert. We know now that cash hasn’t earned anything near that over the last seventeen years. But, if you do the math, you will realize that my grandparents retired in the year 2000, in which case the 8-percent-a-year story isn’t hard to believe at all. Leading up to the pop of the tech bubble, the monkeys swinging around inside people’s heads weren’t just drunk, they were in a state of euphoria. The U.S. stock market* had hit double digit returns five years in a row and talking heads everywhere were proclaiming a new era where the party would continue on forever. It was actually difficult to avoid making money, and people were so blinded, they would believe almost anything.
Many hard-working people fell prey to this story and believed in it so strongly that they were firing their financial advisors if the poor souls didn’t project double digit returns for retirement plans. History was completely thrown out the window. Financial statements became hogwash. It was as if those last five years were all that mattered, and therein laid the problem.
Humans are inclined to focus on recent events and ignore or discount more distant events1. This isn’t so bad if you are trying to forget the ugly sweater you wore to the Christmas party five years ago, but it is bad if you are trying to answer how much money you need to retire. If your money is going to earn double digit returns for the next thirty years, you need a lot less of it than if it earns nothing. Five years was all it took for people to forget that the economy isn’t always rocking and stock markets have down years.
Even more impressive is that we forgot the tech bubble so quickly that for the next seven years after it crashed, the same story was propagated for housing prices. Lo and behold in 2008 we were reminded that housing prices don’t go up forever either. Fast forward to today and here we are again – it’s been eight years since there was a negative return in the stock market* and the economy is showing few signs of stress. Where we will go from here I can’t say. But I will say this: Stay humble, don’t forget about history, and if you hear something that sounds too good to be true, it’s too good to be true.
*Stock market returns refer to the S&P 500 stock index
- Murdock Jr, Bennet B. “The serial position effect of free recall.” Journal of experimental psychology5 (1962): 482.
Mitch writes the popular blog, The Money Monkey, where he focuses on common mental mistakes made by investors, how to avoid being your own worst financial enemy, and thinking about investing in new ways.