Periodically reviewing personal finances and investment accounts to assess their performance against financial goals is critical. Most individuals might consider this an easy task. The numbers within those accounts speak for themselves, right? While the numbers are critical and easy to measure, embedded within those numbers is something extremely important but much more difficult to quantify and assess: the degree to which our own behavioral biases influenced our financial behavior and actions. My colleague, Dylan Potter, previously outlined this topic in ‘The Emotional Biases that Drive Us.’ Having cognitive and emotional biases are a natural part of being human. While they are not always easy to identify or quantify, their existence can wreak havoc on one’s progress towards achieving one’s financial goals. There are two specific behavioral biases that one survey indicates are the most common among clients of financial advisors: loss aversion and recency bias. Perhaps you agree with these findings in assessing your own biases. Let’s examine each of these in more depth for a greater understanding.
Loss aversion bias: “I can’t stomach the thought of a loss.”
Does the prospect of seeing a loss in your investment portfolio bring about a queasy feeling more acute than the thought of going to the dentist? If so, you may be affected by loss aversion bias. Clients with this bias will feel the pain of a loss much more than the satisfaction of an equivalent gain are typically more risk averse. Recognizing that asset allocation and risk tolerance are unique to each individual, an aversion to risk may lead to a less-than-ideal investment allocation given the individual’s objectives and constraints. A portfolio heavily weighted in cash and government debt risks losing real value over time if returns fail to outpace inflation. Excessive portfolio monitoring is also a typical consequence. Seeing losing positions can lead to feelings of regret and a reluctance to sell until the loss is reversed. Conversely, winning positions may be sold too early as clients feel the urge to lock in gains before they turn into potential losses.
In volatile and down markets, loss aversion bias can be particularly detrimental. When an investment’s losses become ‘too much’ for a client to bear, they may feel compelled to cash out to avoid further losses. This behavior occurs in markets repeatedly and is crucial to understand to improve your reactions in similar situations. A Dalbar study found that in 2022, the average equity investor lost 21.17% versus the S&P 500 index, which was down 18.11%. Investors cashing out at or near the bottom to avoid further losses are likely a contributing factor to this underperformance versus the index. Plotting the data seems to support this conclusion. Below is the annual price return for the S&P 500 index and its maximum decline during that year. In most instances, the max drawdown during the year is significantly below the ending return for the index that year. Large percentage drawdowns and significant volatility make it easy to panic and sell at inopportune times simply to avoid the perceived risk of even more pain to come.
Recency bias: “This year’s exceptionally performing investment(s) will undoubtably do so again next year.”
If the above quote resonates with you, you might be influenced by recency bias. This bias involves placing too much emphasis on recent data or events and projecting them into the future. A common example is return chasing, where investors buy or overweight stocks or asset classes with recent superior performance, expecting those returns to continue. However, this is not guaranteed.

Source: Bloomberg
Recency bias: “This year’s exceptionally performing investment(s) will undoubtably do so again next year.”
If the above quote resonates with you, you might be influenced by recency bias. This bias involves placing too much emphasis on recent data or events and projecting them into the future. A common example is return chasing, where investors buy or overweight stocks or asset classes with recent superior performance, expecting those returns to continue. However, this is not guaranteed.
Return chasing can be quite dangerous for investors. When examining the annual returns of 14 major asset classes since 1999, UBS found that the previous year’s best-performing asset class had about a 40% chance of experiencing a loss the following year. This is significantly higher than the 27% chance for a randomly chosen asset class and the 31% chance for a well-diversified portfolio.
Consider this hypothetical scenario: An investor starts her journey at the beginning of 1928 with two options. The first is the ‘Market Portfolio,’ which matches the returns of the S&P 500 index, including dividends. The second is ‘Portfolio B.’ Portfolio B takes a more conservative approach by selecting a mix of companies deemed less risky. As a result, Portfolio B underperforms the Market Portfolio by 1.75% each year when the Market Portfolio has positive returns. However, in years when the Market Portfolio has negative returns, Portfolio B only incurs 75% of the Market Portfolio’s losses. This is known as a downside capture ratio of 75% or 75. The investor will be invested in either portfolio through 2023. Which portfolio will yield the highest value at the end of this period, assuming an equal initial investment in both?
Surprisingly, Portfolio B would have achieved the highest ending value for our investor, ending the time horizon with a value 9.4% higher than the Market Portfolio. This includes Portfolio B underperforming the Market Portfolio in 70 of those years (about 73% of the time) when the Market Portfolio had positive returns. The chart below shows Portfolio B’s ending value versus the Market Portfolio at different levels of annual underperformance in positive market return years (top horizontal) and various downside capture ratios (left vertical). It may seem counterintuitive, but significant downside protection can create value, even if it means sacrificing some performance in normal market conditions.

Source: pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
Overcoming loss aversion and recency bias: A final piece of financial advice
I hope this deeper dive into two common behavioral biases enhances your understanding and awareness, helping you assess whether these biases have affected you in the past or might in the future. Human financial behavior can be erratic and emotionally driven, and it’s not always possible to eliminate these biases through education alone. Once aware of these biases, sticking to a well-defined financial plan and objectively evaluating your responses to market events is the best course of action. Having a financial advisor to remind you of these facts and keep you on track with a plan can be a helpful tool.
I have a theory that when recency and loss aversion bias exist, the advances in technology have made them more acute. We are constantly bombarded with information and accessing it through the phones that are always by our side is almost effortless. In 2021, a CNBC survey showed 49% of respondents checked their investments’ performance once a day or more. This frequent checking is often driven by flashy headlines and loss aversion bias. Recency bias also plays a role, as people feel compelled to see if recent trends (positive or negative) continue. Both biases can lead to impulsive decisions or overreactions, and may contribute to poor investment outcomes.
Do you think these biases affect you in this way? If so, I encourage you to ask yourself why. Are you tempted by the flashy news headlines on TV or the popup notifications on your phone? Perhaps it is simply because technology allows us to and we as humans are bound to the psychology behind variable reinforcement. Does constantly checking your investment portfolio bring comfort or stress? I would hypothesize that far fewer people check the value of their homes on Zillow once a day or more. Importantly, the majority of Americans have more wealth in their homes than in stocks. If they don’t need to constantly monitor their largest asset’s value, why should it be any different for their investment portfolios?
Stay focused and block out the noise. Be sure to recognize possible behavioral biases and how they might derail your financial journey. Keep your goals and financial plan at the forefront of your mind. And whenever you need support, your Howe & Rusling wealth manager is here to guide you every step of the way. You’ve got this!
Disclosures: This material is for informational purposes only and is not intended as investment advice, a recommendation, or an offer to buy or sell any security. Investors should consider their financial situation, risk tolerance, and investment objectives before making any investment decisions. The hypothetical scenarios and historical data presented are for illustrative purposes only and do not represent actual results or the performance of any specific investment. Past performance is not indicative of future results. Discussions of behavioral biases are intended to provide general insights into common investor tendencies. Individual investor behavior may vary, and strategies to address these biases should be customized to fit personal financial goals and circumstances. Data and examples provided in this material, including performance data from Bloomberg and other third-party sources, are believed to be accurate but have not been independently verified. Any reliance on such information is at the investor’s own risk. Investing involves risks, including possible loss of principal. Diversification and asset allocation strategies do not ensure a profit or guarantee against loss. Investors should be aware of the potential for both underperformance and loss in any investment strategy or portfolio. References to third-party studies, such as those by Dalbar and UBS, are included for illustrative purposes and do not necessarily reflect the views or opinions of this firm. We are not responsible for the accuracy or completeness of information obtained from external sources. It is strongly recommended that individuals consult with a qualified financial advisor to develop a personalized financial plan and address any behavioral biases that may affect their investment decisions. Any projections or forward-looking statements regarding market behavior or investment performance are speculative in nature and subject to change based on market conditions and other factors beyond our control.