Issue 1.12
Part 2 of the December 1, 2011 article
Hidden Mistake #3: Loss Aversion Costing You
Definition: Our consistent tendency to avoid loss, rather than acquiring gain.
Typical Example: An investor is more likely to sell a stock which has increased in value, rather than selling stock that decreased. Over time, her investment portfolio is made up of investments that have decreased.
Cure: Don’t think of selling a stock for less than you paid for it as being a loss. It can actually work as a gain for two reasons:
* Tax deduction (which can really help!)
* The other side of opportunity cost: opportunity GAINED (i.e. you can better utilize that money elsewhere)
So, don’t check your portfolio so often. If you don’t know you’ve lost money, you don’t experience the pain. (And riding the roller-coaster of your portfolio’s value is a waste of emotional space.) Since stock prices go up in the long-run, the longer you go without looking at your portfolio, the greater chance of seeing a gain. Sometimes taking that loss really is the best thing you can do.
Hidden Mistake #4: Following the Herd
Definition: The tendency for us to want to do the same thing as a large group of others, with no thought to whether that action is rational or irrational.
Typical Example #1: Buying when prices are high because everyone else is.
Typical Example #2: Selling when prices are low because everyone else is.
Cure: Warren Buffett said, “Be fearful when others are greedy and greedy when others are fearful.”
Keep this in mind when making your next financial decision. If everyone is telling you to buy this or buy that (i.e. gold, silver, real estate) do the opposite. In the financial investment world, if it’s too good to be true, it usually is. Write up an investment policy statement or contract. Include factors such as:
* Investment objective
* Investment goals
* Desired asset allocation and diversification
* Summary of your risk tolerance
* Rebalancing schedule
Before making any changes, consult with this contract. You can also take advantage of this inherent tendency to do what’s approved by others to affect positive behavior. For example, let’s say you trying to pay off debt. Tell your 3 closest friends, make an informal contract, sign your name at the bottom, and then email it to them. The pain you would incur from breaking that contract is high relative to the pain of breaking your behavior if you went about it alone.
David D. Polatis, CEP of Senior Advantage can be contacted at 435-986-9222.