Whether you’re buying your first stock or you’ve purchased many over many years, you’ve probably done a lot of research and calculations and, if you’re like most investors, you keep track of whether your stocks are going up or down.
Like many investors, if your stock price goes down, you more than likely hold onto it thinking that it’s just a temporary setback, might be undervalued and will more than likely go up soon. In some cases you might even consider purchasing more of the same stock.
As those days turn into weeks and months however, and your stock keeps losing value, you might want to consider something that most investors don’t; selling that stock at a loss.
This unfortunate trait even has a name; the “disposition effect”. What it means psychologically is that humans don’t like to admit that they’ve made a mistake (and thus are losing money) because, well, it’s too depressing. Instead most investors simply ignore the losers in their portfolio and focus on the winners.
Interestingly, when it comes to mutual funds, most investors don’t have nearly as big a problem of selling the losers that they have in their portfolio because they can blame someone else for its poor performance, including the fund manager.
The reason for the difference between the way humans treat loser stocks and loser mutual funds is something called “cognitive dissonance”. What it means is that, when something happens that goes against the way we think the world should be (our “worldview”), many humans have a very hard time accepting the fact that they made an investment decision that was “bad”. It’s even worse for people who believe themselves to be the kind that make “good” decisions.
The lesson to be learned today is simply this; don’t let your ego get in the way of making a good decision. While holding onto the shares of a particular company that still shows promise is usually a good idea, holding onto a stock that keeps dropping in value week after week, month after month, probably isn’t.
Interestingly, if you can convince yourself that someone else is to blame for the “bad” stock that you own, say the person who recommended it to you or the analytical model that you used when you made your purchase decision, it might be easier for you to dump that stock. Yes, it sounds a bit silly, but if it works it’s better than holding onto a loser stock that lowers the overall performance of your portfolio.
Of course there’s always the fact that you could own up to your bad investment decision and, quite frankly, that’s the healthiest choice. It seems like the most difficult for many investors however, so if you can do it, you definitely should pat yourself on the back.