By Siria Xiyueyao Luo
Hope Might Not Be a Viable Investment Strategy
In 2014, a client sought help from Michael Piershale, a financial advisor in Crystal Lake. The client had lost $30,000 in her investment even though part of her loss could have been avoided by just selling her losing stocks. By doing this, she could have “used the loss to offset the gains and eliminated the capital gains tax”, said Piershale. This example demonstrates what is called the disposition effect in academic research: due to loss aversion and other factors, investors have the tendency to keep losing stocks for too long and sell winning stocks too soon. This is considered irrational, as decisions to sell or keep stocks should be based on the expectation of whether their worth will go up or down, not on the original buying price. If you expect an investment to lose in value, you should sell it, and if you expect it to increase in value, you should keep it. So why do many investors still cling to losing stocks?
The Role of Hope
Some practitioners suggest that holding on to losing investments might be due to hope. For instance, Le Roy Gross writes in his manual for stockbrokers (p. 150):
“Many clients, however, will not sell anything at a loss. They do not want to give up the hope of making money on a particular investment, or perhaps they want to get it even before they get out. The ‘getevenitis’ disease has probably wrought more destruction on investment portfolios than anything else.”
Some researchers suggest that hope should be included in economic models to explain and predict investors’ buying and selling behaviors. A research team from the VU University in Amsterdam recently found that the emotion of hope is positively associated with the tendency to keep losing stocks. They argue that hope is more prominent, especially in bad situations, and “seeing the price of held stocks decreasing” is definitely one of those situations.
Normally we would think people invest for earning more money. However, the researchers found that although people still have a high hope of earning money even when holding losing stocks, what drives them to keep or sell is the hope to break even. Indeed, the Piershale agency found this happens “over and over again – people hanging onto losing stocks for longer than they should”.
This hope to break even is not only prevalent in the stock market. Similar examples can be found in the housing market and gambling market. For instance, in Finland (from 1987 to 2003), after the house prices dropped below the initial purchase price, people sold their houses as soon as they reached the buying price again, even though they might have ended up higher. Similarly, in horse races, bettors who lose money tend to prefer wagers that could help them to break even at the end of the day, no matter how risky the odds.
Who Feels Hopeful and When?
Personality and context both impact the feeling of hope. Some people naturally are more likely to feel hopeful. They see the possibilities even in difficult times, or they can feel a stronger desire for unlikely things. For instance, Max is always hopeful about his academic performance but Charlotte is not. The same person might also feel more or less hopeful depending on the situation. For instance, Aisha would “hope” to pass an exam only when she is highly uncertain about passing. But she would “expect” to pass this course if she is very confident and certain about passing. In other words, people normally feel a stronger hope when they are in highly uncertain or bad situations.
Indeed, the researchers from Amsterdam found that people who chose to hold the losing stocks have a stronger hope to break even than the others who do not have such hope, irrespective of their age, gender, or investing experiences.
How to Improve?
Having learned that strong hope is holding people back from quitting, what can we do to improve our decisions? Here are some “pills” to alleviate the “getevenitis” disease:
- Financial knowledge. The more we know the basic truths and knowledge of investment, the less likely it is that we will fall prey to gut feelings or emotions.
- Experience. The more experienced we get with investing, the more we will get used to the volatility of the stock market. As a result, we are less likely to react emotionally to the ups and downs of stock prices.
- Counter-hope-thinking. If we are encouraged to think about reasons why the price of the held stock is not going to bounce back, we are more likely to accept the loss and sell the losing investment.
- Letting others make the decision. Given that we might be too hopeful to sell our losing stocks, letting others make the decision could be a possible solution. For instance, investing platforms could implement an automatic selling system that sells the stock once it hits a pre-set losing point. Or, simply let your pet press the ‘sell’ button!
Exceptions
There are some exceptions where keeping the losing investment might actually be a good idea. This will greatly depend on your investment experience and will require you to evaluate the true value of the equity. If your analysis concludes that the current price of the losing stock is undervalued and will bounce back eventually, it might indeed be a good strategy to hold on to the losing stock. Some investment agencies even trade based on “contrarian strategies” – buying when others are selling off. As an investor, then, the challenge is to understand whether you’re dealing with well-founded expectations or simply hope.
This article was edited by Ankit Shanker
