Last month in another country, a man we’ll call Jim, watched one of his beloved investments tumble 16% in the space of as many days. Jim’s investment is (or was) ‘beloved’ because he’d attached all sorts of historical and emotional significance to it.
The company, Jim told his adviser, was going to change the world. Jim had independently booked his ticket to enjoy the ride with them by investing several hundred thousand dollars of his and his wife’s money.
That company was Apple. Not such a bad outfit, but every company can be prone to downgrades, disappointments and eventually failing to outdo their past achievements.
Jim loaded up when Apple was trading sub $100 and he was there as they hit a high of $134. His adviser, who’d previously cautioned against the concentration risk, told Jim he’d made over 30% in a one horse town, so it was time to take some of those winnings and diversify elsewhere.
Jim told his adviser you don’t sell your favourite company, especially one that’s making you filthy rich. By selling you also have to pay capital gains tax. No. No. No.
Since that peak Apple has ridden a rollercoaster, but the trend has been down – to the point it lost 6% in an hour last month after a lacklustre earnings report. That put Jim back below where he’d started. Essentially two years went down the tubes and now Jim can’t bring himself to sell because that would mean selling at a loss.
As you might notice, selling at any time is unacceptable for Jim because beyond being anchored to the idea of riding Apple to the moon, he has no investment plan to speak of.
Out of fear Jim also keeps a torch burning for a random spike where Apple might shoot up and he can exit without a loss. Yet we all know the moment Jim’s square again he’ll reassess, believing he’s back on a winner and push the sell idea further into the future.
All this kooky behaviour isn’t anything new, so despite Jim’s irrationality he’s not to be laughed at because we’re all prone to it. It can happen when we invest, but it’s exacerbated when we invest (or gamble) on individual shares.
As a company is more tangible than a fund, it becomes not just an investment, investors can develop an emotional attachment. Investors have been known to get on a first name basis with the board and directors of a company, despite the fact the board and directors have no clue the investor exists.
Getting emotionally attached leads to a whole host of mistakes – concentration risk, anchoring, confirmation bias, overconfidence, loss aversion. While the volatility a single share exhibits only increases the severity of the emotional rollercoaster.
While we’re all prone to behavioural howlers when investing, they’re not as pronounced when your money sits in a selection of funds with unexciting names like “Vanguard 500 Index Fund Investor Class”.
On the day Apple tanked 6% in an hour, that unexcitingly named fund based on the S&P 500, which has Apple as its biggest holding, gained ground. While Apple was wallowing, its stable mates were enjoying a decent run.
Investing isn’t hard. Nor does it have to get emotional. Remove the biggest and most obvious risks, then spread your money around appropriately. Remember the rough start to the year? Most portfolios and their owners have already forgotten it because they’re back in the black.
Jim’s still hoping Apple has a new plan to conquer the world because smart phone sales are declining and no one wants an iWatch.
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