An Alternative Way to View Bad Stocks and Lost Money
There are many aspects to Behavioral Finance. The natural instinct to hang on to a poorly performing stock in hopes that it will make a come-back is but one glaring example.
Most of us have a bad habit of holding onto our losers rather than getting rid of them and replacing them with a better stock. Pushing the Enter button to sell a loser is difficult because it puts the final stamp on the fact that you just lost a lot of money and there's no turning back, Ouch! That hurts. It's humiliating, it's depressing, it feels like a painful confirmation that your judgment might be faulty and you made a bad decision, and it makes you feel like a fool.
But wait! We know for a fact that no matter how good we are at stock analysis, on average, one out of five of our stock picks will under-perform our expectations. That doesn't mean our judgment and decision making is faulty 20% of the time. It only means that one out of five of our stock picks will under-perform. Period! It isn't our fault, so we shouldn't beat ourselves up about it.
Under-performers typically under-perform for reasons beyond our control. Corporate management is misrepresenting the data, or withholding key information, China's veil of a prosperous state-run economy suddenly unravels, or, as likely as not, an unexpected event in one of our own US financial sectors or industries has caused some of our stocks to tumble. The list goes on, including International issues with trading partners, fluctuating interest rates, wars, recessions, and so on. But here's the fun part; statistically, one of those five stocks we pick will out-perform our expectations, and the other three will perform according to our expectations.
What follows is an example of a different way of thinking about bad stocks and lost money.
The premise of this example is that we shouldn't think of money as money. We should think of it only as a means to an end. In this case, gasoline. Here's the plot:
Joe gets what he feels is a good deal on an old pickup truck that runs smooth and keeps up with interstate traffic. Joe fills up the gas tank Sunday night because he has to drive 75 miles on Monday to catch a flight to Saginaw. Joe gets on the interstate on Monday morning and 20 miles out of town his pickup starts sputtering and slowing down. Then, it lurches ahead as if everything is going to be OK, but then it sputters and slows down again. This goes on for ten minutes and finally Joe spots a used car dealership up ahead, close by the interstate. He takes the off ramp and sputters his way into the dealer's parking lot.
The dealer's eyes light up and he says to Joe, "Hey buddy, I trade a lot of vehicles on this lot and I know a guy that's looking for an old pickup truck just like that one. He'd buy that thing from me right now. Wanna make a deal?"
Joe looks at his watch and realizes that at the rate he's going he'll miss his flight. "I gotta catch a flight to Saginaw," Joe says. "Can you fix this thing?"
"Nope," says the dealer, "I just buy 'em and sell 'em. Wanna make a trade?"
Desperate, Joe looks at his watch again and says, "Whadda you got? I'm in a hurry."
The dealer points to a clean, compact, used, tan Toyota sedan about 20 feet away and says, "That's a very nice little car; runs great, never been in an accident. I'll trade you that one for your pickup, straight across."
Joe looks at his watch again, then says, "Straight across, huh? I just filled this thing up with $40 worth of gas last night. I'm not giving you the gas."
"Suit yourself," says the dealer. "The Toyota is sittin' on empty. Why don't you just siphon the gas out of the pickup into the Toyota?"
"You got a siphon tube?" Joe asks.
"Sure do," says the dealer. "I'll get you the tube and you can transfer the gas into the car while I'm fillin' out the paperwork."
Joe transfers the gas, signs the paperwork, gets in his Toyota that, by the way, runs a lot better than the pickup, gets him to the airport a little earlier than he expected, and he has plenty of time to catch his flight to Saginaw.
The moral of the story:
The pickup truck (stock) wasn't running as well as Joe had expected, so Joe went to a dealer (the stock market), took the gas (money) out of the pickup (poorly performing stock) and put it to work in a Toyota (a better performing stock).
As far as his goal was concerned (catching the flight to Saginaw), the pickup just wasn't going to get him there. But making the trade and moving his gas over to the Toyota was what got him to his goal.
By the way, the flight to Saginaw was for a job interview. Joe got the job, plus a hefty hiring bonus based on his ability to make sound decisions unimpaired by emotion. The bonus more than made up for the money he might have lost on the trade for the Toyota. To this day, Joe still uses the Toyota to commute to work.
Basically, it's a question of which company is going to recover your lost money the fastest; the one you own right now that's sputtering, and sometimes lurching along just enough to trick you into holding it just a little longer, or the one you could own that runs smooth and fast and gets you there quicker? Remember, you may love the vehicle (stock), but the vehicle doesn't love you back. All you have to do is transfer the money from one poorly performing investment vehicle into the better performing investment vehicle. - It's that simple.
Most of us have a bad habit of holding onto our losers rather than getting rid of them and replacing them with a better stock. Pushing the Enter button to sell a loser is difficult because it puts the final stamp on the fact that you just lost a lot of money and there's no turning back, Ouch! That hurts. It's humiliating, it's depressing, it feels like a painful confirmation that your judgment might be faulty and you made a bad decision, and it makes you feel like a fool.
But wait! We know for a fact that no matter how good we are at stock analysis, on average, one out of five of our stock picks will under-perform our expectations. That doesn't mean our judgment and decision making is faulty 20% of the time. It only means that one out of five of our stock picks will under-perform. Period! It isn't our fault, so we shouldn't beat ourselves up about it.
Under-performers typically under-perform for reasons beyond our control. Corporate management is misrepresenting the data, or withholding key information, China's veil of a prosperous state-run economy suddenly unravels, or, as likely as not, an unexpected event in one of our own US financial sectors or industries has caused some of our stocks to tumble. The list goes on, including International issues with trading partners, fluctuating interest rates, wars, recessions, and so on. But here's the fun part; statistically, one of those five stocks we pick will out-perform our expectations, and the other three will perform according to our expectations.
What follows is an example of a different way of thinking about bad stocks and lost money.
The premise of this example is that we shouldn't think of money as money. We should think of it only as a means to an end. In this case, gasoline. Here's the plot:
Joe gets what he feels is a good deal on an old pickup truck that runs smooth and keeps up with interstate traffic. Joe fills up the gas tank Sunday night because he has to drive 75 miles on Monday to catch a flight to Saginaw. Joe gets on the interstate on Monday morning and 20 miles out of town his pickup starts sputtering and slowing down. Then, it lurches ahead as if everything is going to be OK, but then it sputters and slows down again. This goes on for ten minutes and finally Joe spots a used car dealership up ahead, close by the interstate. He takes the off ramp and sputters his way into the dealer's parking lot.
The dealer's eyes light up and he says to Joe, "Hey buddy, I trade a lot of vehicles on this lot and I know a guy that's looking for an old pickup truck just like that one. He'd buy that thing from me right now. Wanna make a deal?"
Joe looks at his watch and realizes that at the rate he's going he'll miss his flight. "I gotta catch a flight to Saginaw," Joe says. "Can you fix this thing?"
"Nope," says the dealer, "I just buy 'em and sell 'em. Wanna make a trade?"
Desperate, Joe looks at his watch again and says, "Whadda you got? I'm in a hurry."
The dealer points to a clean, compact, used, tan Toyota sedan about 20 feet away and says, "That's a very nice little car; runs great, never been in an accident. I'll trade you that one for your pickup, straight across."
Joe looks at his watch again, then says, "Straight across, huh? I just filled this thing up with $40 worth of gas last night. I'm not giving you the gas."
"Suit yourself," says the dealer. "The Toyota is sittin' on empty. Why don't you just siphon the gas out of the pickup into the Toyota?"
"You got a siphon tube?" Joe asks.
"Sure do," says the dealer. "I'll get you the tube and you can transfer the gas into the car while I'm fillin' out the paperwork."
Joe transfers the gas, signs the paperwork, gets in his Toyota that, by the way, runs a lot better than the pickup, gets him to the airport a little earlier than he expected, and he has plenty of time to catch his flight to Saginaw.
The moral of the story:
The pickup truck (stock) wasn't running as well as Joe had expected, so Joe went to a dealer (the stock market), took the gas (money) out of the pickup (poorly performing stock) and put it to work in a Toyota (a better performing stock).
As far as his goal was concerned (catching the flight to Saginaw), the pickup just wasn't going to get him there. But making the trade and moving his gas over to the Toyota was what got him to his goal.
By the way, the flight to Saginaw was for a job interview. Joe got the job, plus a hefty hiring bonus based on his ability to make sound decisions unimpaired by emotion. The bonus more than made up for the money he might have lost on the trade for the Toyota. To this day, Joe still uses the Toyota to commute to work.
Basically, it's a question of which company is going to recover your lost money the fastest; the one you own right now that's sputtering, and sometimes lurching along just enough to trick you into holding it just a little longer, or the one you could own that runs smooth and fast and gets you there quicker? Remember, you may love the vehicle (stock), but the vehicle doesn't love you back. All you have to do is transfer the money from one poorly performing investment vehicle into the better performing investment vehicle. - It's that simple.