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Without looking, what was your portfolio return last year? Don’t check your statement – just answer. Next, visualize what the market performance looked like over the past five or 10 years. Now look it up and compare it with what you conjured up in your mind.
Aside from professional money managers, most people will find they were way off. And while we intuitively know that our memories about past performance are not like an accounting ledger, it might still surprise us to learn just how distorted our recollection of past returns and market patterns truly are.
The problem with this, according to a paper just published in The Quarterly Journal of Economics, is that these inaccurate memories about past returns fuel expectations about future market performance and in turn, influence investing decisions. And you guessed it: not for the better.
The researchers found that investors’ beliefs aren’t formed from the full record of what actually happened, but from the fragments they recall at a given moment. When markets rise, those gains cue people to recall other upbeat periods and to envision a future that looks just as good. But when markets fall, losses cue painful memories of past downturns.
This “cue-recall-simulation” loop means that recalled experiences do most of the work in shaping investor forecasts, not actual market return patterns. The study found that remembered returns were more predictive of investor trades than real performance data.
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This might be particularly relevant to newer investors who really haven’t experienced what a protracted, grinding bear market feels like. Think about it: since the financial crisis of 2008/09, any market turbulence was pretty short-lived by comparison, even the plunge when COVID brought the planet to a standstill. Everything has bounced back relatively quickly whenever things have gone awry over the past 15 years.
We’ve had an unusually long run of good markets and the stories our brains tell us about that stretch aren’t neutral. This new research on investor memory shows that even when performance is average, our skewed recollections of it can still lead to poorer investing decisions. These memories are constructed based on recency (what’s been happening lately) and saliency (things that created an outsized emotional response, like a big market drop).
If markets are up, we tend to lean more heavily in recalling past up markets and project that enthusiasm into future expectations. But if markets are down, our brains are flooded with recollection of the pain of past losses, which in turn make us more likely to sell reactively to bad news.
You might think this is only a concern for active traders. And while it’s true that they are exposed to more cues because they pay more attention to quarterly earnings and 24/7 news coverage of global markets, buy-and-hold indexers are not immune.
The bias could show up in different ways, such as contribution timing, skipping a scheduled rebalancing, or just pausing a plan when sentiment gets ugly. As much as “tuning out the noise” is part of the ethos of a buy-and-hold investor (indexer or otherwise), there are ways one can rationalize doing just the opposite.
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But there may be an antidote to our biased beliefs of past returns affecting our investing decisions: a journal. It doesn’t have to be an onerous exercise, and it can be as simple as adding it to your annual review. Maintain a document, online or on paper, that captures your thoughts and emotions about the past year.
It can be as simple as jotting down a brief note or two like, “I was tempted to buy AI-related stocks because of all the AI hype this past year” or “When the tariff trade war kicked off at the beginning of the year, I paused my contributions to equities because it felt like a recession was coming.”
The power in this exercise will only reveal itself over the years. When you review returns over time along with your record of emotional responses, it may reduce the bias our brains inject into our unaided memories. It may also eventually help us be more able to tune out future noise.
Instead of overemphasizing only recent performance and emotionally charged periods of extreme market volatility, we also get to factor in the long, mundane stretches in between, which are otherwise forgotten but contribute positively to our long-term performance.
If you don’t write down your financial history, your brain will rewrite it for you.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.
