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13 May 2016
A few years back there was a bestselling book called “He’s Just Not That Into You.” Its goal was to get women to 1. Stop making excuses for dead-end relationships and 2. Move on to better opportunities. It turns out that this is excellent advice for stock investors as well.
Understandably, investors fall in love with stocks that have made them a lot of money. The problem comes when they are unable to break up. Becoming emotionally connected to a stock is a classic mistake and has resulted in many investors taking a “round trip”—holding a stock as its price rises and then gradually falls back to its starting point or lower.
In fact, a study by Investor’s Business Daily found that in a bear market, market-leading stocks’ prices decline 72% on average from their highs.
The key in investing is to look to the future, not the past. Investors should periodically evaluate their holdings with a critical eye. For example, if you bought a stock because its price-to-earnings ratio was exceptionally low, you should revisit that P/E ratio when deciding whether to hold or sell the stock. If it’s well above the market, it could be time to sell the stock and buy one with more potential upside.
Of course, our judgment can get cloudy when a stock has been good to us. Take Chipotle Mexican Grill, Inc. stock, symbol CMG. After gaining 208.28% over three years, it would have been a hard one to sell in August of 2015. But that would have been the right move, because it has fallen 38.75% since then.
One reason it’s hard to sell has to do with an emotional phenomenon known as the status quo bias. Status quo bias can occur in many aspects of our lives; for investors it often means sticking with a position rather than ripping off the Band-Aid and moving on.
There are two effective ways to conquer the status quo bias. The first is to develop a disciplined asset allocation strategy that includes regular rebalancing. Rebalancing at least once a year forces us to shift gains from our past winners (which may be ready for a fall) into weaker-performing categories that may be primed for gains.
Another key is to seek out the opinion of an objective professional. A good advisor won’t have your emotional attachment to any stock, and can serve as a valuable reality check.
Rather than falling in love with a stock, investors should fall in love with the performance from an overall portfolio, one that is designed to minimize risk and zero in on opportunity. Because in the end, that stock you’re loyal to won’t be loyal to you or love you back.