The Extrapolation Trap
Recency bias is the tendency to treat recent experience as a reliable guide to the future — to extrapolate the last few years' returns forward and assume they represent the new normal. It is one of the most pervasive and costly biases in retail investing, because financial markets are mean-reverting: periods of strong returns are followed by periods of lower-than-average returns, and vice versa. Investors who chase recent performance are, systematically, buying high.
The mechanism is straightforward. A fund or asset class that has performed strongly for two or three years attracts media coverage, generates impressive past-return charts, and becomes the subject of conversation. Investors, experiencing the availability of vivid recent gains and the social proof of others' enthusiasm, pour money in. But by the time returns are compelling enough to attract retail inflows, valuations have often already risen to reflect the strong performance — and the forward return is lower, not higher.
The DALBAR Evidence
DALBAR's annual "Quantitative Analysis of Investor Behavior" report provides the most systematic evidence of performance chasing's cost. DALBAR tracks not just what investment funds returned, but what the average investor actually earned — accounting for when money flowed in and out of funds. The finding, replicated over decades: the average equity investor earns 1.5–2% per year less than the average equity fund, purely because of mistimed entry and exit driven by performance chasing.
This gap — sometimes called the "behaviour gap" — compounds devastatingly over time. An investor who earns 1.5% less per year than the index over 30 years ends up with roughly 36% less final wealth than the patient investor who simply held and did nothing.
The Fund Selection Problem
Academic evidence confirms what intuition suggests. Friesen and Sapp (2007) found that mutual fund investors systematically buy after periods of strong performance and sell after periods of weak performance. Funds with the highest recent inflows subsequently underperform funds with the lowest inflows. Buying the top-performing fund of the past three years is a consistently poor strategy — not because past performance has no information content, but because it is the wrong kind: high recent returns often mean lower future returns (mean reversion), not higher.
Why It Persists
Three biases conspire to make performance chasing feel rational. Recency bias makes the last few years' returns seem like the natural baseline. Availability bias makes recent gains vivid and memorable in a way that distant long-run averages are not. And social proof — the visible enthusiasm of other investors and media coverage — makes joining the crowd feel sensible. Each bias individually is powerful; together they reliably produce a wave of money arriving at the worst moment.
The Antidote
The correction is mechanical and unglamorous: invest in a diversified index fund, make regular automatic contributions, and ignore recent performance when making allocation decisions. Rebalancing toward recent underperformers — selling what has done well and buying what has done poorly — is the direct inverse of performance chasing, and it is what the evidence supports.