Tilson, Heins, and Recency Bias

How did so many investors and analysts fail to recognize the looming economic and stock market crises in recent years? In their latest Forbes column, Whitney Tilson and John Heins say that “recency bias” is a big reason — and a major challenge facing all investors.

“One of the more insidious investor biases is a natural tendency to assume that the future will look like the recent past,” write Tilson and Heins in explaining recency bias (sorry no link — the article is available only in Forbes magazine and is not online). “The best investors don’t fall into this trap.”

Tilson and Heins say Bridgewater Associates founder Ray Dalio recently offered some interesting words of caution pertaining to this phenomenon: “If you optimize your investment strategy to work in a certain period without having a deep enough understanding of how it would work in all circumstances, including circumstances that did not occur within the period that’s your frame of reference, you will inevitably do very badly,” Dalio recent wrote to investors. “That is what happened to a lot of people in 2008.”

Recency bias works both ways, Tilson and Heins note; it can also cause investors to flee good stocks that have had recent price declines. Two current examples they give: Berkshire Hathaway, whose intrinsic value they peg around $113,125 a share, making the stock a bargain at its current $90,000ish price, and American Express, which they think will bounce back strong.

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