Don’t Let Recency Bias Lead You Astray

Recency bias is the tendency for people to overweight new information or events, projecting them into the future while ignoring long-term evidence. This bias causes many investors to engage in performance-chasing—tending to buy stocks and funds after a period of good performance and tending to sell after a period of poor performance.

Buying after periods of strong performance (when valuations are higher and expected returns are now lower) and selling after periods of poor performance (when valuations are lower and expected returns are now higher) is not a prescription for successful investing. Yet, because of recency bias, it is the way many individuals invest. What disciplined investors do is the opposite—they rebalance to maintain their well-thought-out allocation to risky assets.

Performance of Largest Stocks

With their recent spectacular performance, I thought it a good idea to review the historical performance of the 10 largest stocks. Before doing so, let’s take a brief look at how the composition of the 10 largest stocks changes over time.

At the start of 2024, the 10 largest US stocks were Apple AAPL, Microsoft MSFT, Alphabet GOOGL, Amazon.com AMZN, Nvidia NVDA, Meta Platforms META, Tesla TSLA, Berkshire Hathaway BRK.B, Eli Lilly LLY, and Visa V. There was a lot of turnover (40%) from the start of 2023, with Nvidia, Meta, Tesla, and Eli Lilly joining the list, while UnitedHealth UNH, Johnson & Johnson JNJ, Exxon Mobil XOM, and JPMorgan Chase JPM left. Such turnover is quite common. For example, 10 years earlier, at the start of 2014, only Apple, Microsoft, and Berkshire Hathaway were in the top 10. If we go back 30 years to the start of 1994, not a single one of 2024′s top 10 managed to stay there for the full period. The 10 largest then were Exxon Mobil, Coca-Cola KO, Walmart WMT, Raytheon, Merck MRK, Procter & Gamble PG, GE GE, PepsiCo PEP, IBM IBM, and Johnson & Johnson.

With our focus on recency bias, our review of the performance of the largest stocks will examine returns over the three-, five-, and 10-year periods before and after the stocks joined the list of the 10 largest. The data covers the period 1926 through 2023 and includes stocks in the CRSP database.

Highflyers Return to Earth

In the 10 years before becoming one of the largest 10 US stocks, they returned 11.8% per year. In the five years before doing so, they returned 20% annually. And in the three years before doing so, they returned a spectacular 27.2% annually. The combination of recency bias and the fear of missing out, or FOMO, can lead investors to overweight these companies. What investors subject to these biases likely fail to understand is that spectacular performance is often fueled not just by earnings growth, but also—and often mostly—by multiple expansion. Multiple expansion lowers the cost of capital for companies, which lowers the expected returns to investors. So, how did these highflyers perform in the periods after they became a top-10 stock?

In the three years after joining the list of the largest 10 companies by market cap, these stocks returned just 0.5% per year. In the five years after doing so, they did even worse—losing 0.9% per year. And in the 10 years after doing so, they performed worse still, losing 1.5% per year. In other words, after their spectacular performance allowed them to become one of the 10 largest stocks, over the next three-, five-, and 10-year periods, these once highflyers underperformed totally riskless one-month Treasury bills.

Investor Takeaways

Because investors can only buy tomorrow’s returns, not yesterday’s, one of the keys to successful investing is to avoid recency bias and FOMO, which can cause investors to abandon even well-thought-out plans.

Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future: The Keys to Successful Investing.