Two related concepts, anchoring and recency bias, can trick your brain into making poor risk management decisions. Wikipedia describes recency bias as “a cognitive bias that favors recent events over historical ones,” and defines anchoring as “a cognitive bias whereby an individuals decisions are influenced by a particular reference point or ‘anchor’.”
What this means, in short, is that anchoring and recency bias are enemies of objective assessment.
It’s kind of like when you plunge into cold water: it’s shocking, but after a minute or so your body adjusts somewhat. It’s still uncomfortable, but it feels more bearable. Even if you’re about to die of hypothermia.
Or, take the proverbial frog boiling slowly in a pot. At first the water is just pleasantly warm. Then uncomfortably hot. Only when it’s too late does the frog think, Oh, no!
Why do brains work this way?
Although anchoring and recency bias can lead you to be apathetic when you should be upset, they’re also natural phenomena that improve humans’ adaptation to changing conditions. After a massive natural disaster, it does no good to constantly bemoan your situation instead of buckling down and starting to rebuild, WALL-E end-credits style. At first, the change feels shocking because your anchor is to a better situation in the past, but eventually, you adapt and accept the new conditions as a baseline to build on going forward: a new anchor. That’s how humans have survived for hundreds of thousands of years.
So, to handle anchoring and recency bias constructively, you need to be aware of them and consciously take their effects into account when making decisions. From a risk management perspective, the key thing to know about anchoring and recency bias is that they cause you to underestimate or overestimate risk over time. An argument can be made that they are subtle factors driving oscillations in systems to greater amplitude.
How about an example of anchoring in practice?
The stock market is a great example of how our brains can get tricked into thinking some current trend will continue in perpetuity, despite the fact that this never happens. “This time is different” fails comically often.
For example, in a time of exuberance, expectations for future stock prices tend to move up with increasing stock prices. That’s recency bias in action. Analysts hike their forecasts, investors see positive returns and grow attached to those numbers in their portfolios, momentum builds, and last year’s stock price becomes an anchor of sorts. For some people, their ultimate anchor may be their purchase price, and it can feel hard to believe the fair market price could ever go lower than that.
But anchors are ephemeral, and reversals can and do occur. Late last fall, a reversal occurred from uptrend to downtrend in the US stock market. Suddenly, good earnings reports didn’t propel stocks forward. Investor confidence was slow to fade through the winter, but eventually many analysts began lowering their price targets, perhaps afraid a $360 forecast might look silly compared to the sub-$100 current price of various former market darlings.
Does this work in reverse, too?
Yep. In a market downtrend, after a period of mental shock and struggle, anchoring tends to kick in again, and it begins to feel like the downtrend will continue forever. But at some point, actual negative economic conditions may justify only a portion of the declines in share prices. The pendulum swings too far. And that opens the door for another reversal to occur, as one did in July 2022. (Time will tell if it’s a fake-out or the start of a longer-term uptrend.)
This phenomenon felt especially acute (and painful!) in early 2009, when the market was spiraling downward and investing felt akin to lighting cash on fire. However, in spring 2009, a reversal occurred, sudden and sharp. (It’s possible that the bank stress tests conducted around then were a catalyst or booster for that reversal, by increasing people’s confidence in financial safety and soundness.) Many investors, anchored to the steep declines of prior months, believed prices would remain low or go even lower, and they stayed out of the market and missed much of the rebound for many years.
All of which is to say: we get used to the most recent thing—whatever that is. Then we start to anchor on it. This is true far beyond financial markets. It has far-reaching implications for almost every aspect of life and our expectations about the future. If something horrifying happens after a string of good events, it feels horrifying. Gutting. Appalling. But if that same thing happens after a string of similarly horrifying events, numbness tends to kick in. Resignation. Cynicism. Call it anchoring sickness, maybe: the same events can cause very different reactions depending on what preceded them.
But in good risk management, data should determine action, not attachment to prior or recent history. If the planet is burning up, that’s not ho-hum, just another Monday, that’s horrifying, and it demands action, even as it happens more and more often. We’re fighting our own psychology, in addition to fighting global warming, the creep of authoritarianism, or the current or next pandemics.
So how can I avoid falling victim to anchoring sickness?
Keeping a journal is a good countermeasure if you’re comfortable doing that. Writing on paper or on a document saved on an encrypted hard drive can be cathartic and relatively private, if you secure the journal well (a topic with a lively debate around it!). By writing what you feel and think at a particular moment, you can refer to it later as a reminder.
More broadly in life, another way to fight anchoring is to maintain contact with various groups of friends who know you and your history in different contexts: from work, school, and hobbies. If you start to drift too far from the person they originally got to know, one of them may say something. If that happens, don’t lash out. They may or may not be right (maybe they’re the one who’s changed, or maybe you’ve all grown apart and you’re fine with that), but it’s a good opportunity to consider what you’re hearing and check in with yourself, like reviewing an old journal entry. Maybe you need to course correct, and maybe you don’t. It’s the check-in that’s important to fight anchoring and recency bias, which erase the distant past and the future in favor of the recent past.
Lastly, read news from outside your usual sources. I do this every morning when I look at Google News, which pulls together articles from a broad spectrum of publications. Don’t anchor on any single source as the canonical truth.
It’s hard to fight our own brains’ tendency to anchor and to adapt to the most recent environment. But open minds are far more independent, and far harder to subvert, than minds that become numbed by recent trends and forget that there are many other possibilities just over the horizon. It’s worth the effort—and the discomfort—to stay open-minded and fight the tricks our brains play on us.
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Extra, Extra!
Three links from the depths of my bookmark archives; think of these as tangential extras for curious readers:
1. Here comes the sun—to end civilization - by Matt Ribel in Wired - and how capacitors might save us.
2. Are you a scanner? - by Barbara Sher in GetMotivation - I read this and see myself (hattip Mark Dykeman in How About This).
3. At the top of her field, a Covid-19 researcher fights back against a different kind of virus: sexism and power imbalances in science - by Shraddha Chakradhar in STAT - even at the top of STEM fields, it can be a struggle to be viewed as equal.
Tricks of Anchoring and Recency Bias - Don’t Fall for It
Trial #2 of your Newsletter. Very good again Stephanie. My sense is financial risk is captured very well in the writing of Michael Lewis and his accessibility is second to none.
Ray Dalio, in his book “Principles for Dealing with the Changing World Order” talks about trying to get past our bias associated with assuming things will always happen the way we’ve experienced them in our lifetimes, instead of learning from the past beyond our own lifetime, and even beyond the lifetime of our current civilization. Just because something hasn’t happened in my lifetime, doesn’t mean it hasn’t happened many times in past history. It’s an interesting take on the recency bias.