We are all above average - at holding onto investment losers and selling winners
Endowus Insights

We are all above average - at holding onto investment losers and selling winners

Updated
October 13, 2021
published
August 31, 2017
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"The investor's chief problem - even his worst enemy - is likely to be himself."
  • Benjamin Graham

At least 70% of people think that they are above-average drivers, despite the statistical impossibility.

This phenomenon known as illusory superiority translates into investing as well, which means that we are predisposed to believe that we are all really better-than-average investors.

You may have been really smart to own Tencent or Apple for the last 10 years, but the truth is, the odds are stacked against you and I in consistently picking winners. In an efficient market, a company's stock price already reflects the collective knowledge of all market participants. Stock-picking means that you are confident you know something that isn't already reflected in the price ?and most others are dunces.

When it comes to money and investing, we're not always as rational as we think we are. Studies show that investors don't adhere to the basic tenet of investing: buy low, sell high. When the stock market goes up, investors put more money in it. And when the market goes down, they sell.

We tend to hold onto losers and sell winners.

There's even an entire field of study that looks at this tendency to make illogical financial decisions called behavioural finance. New York Times published an interesting article on biases which contribute to why we think we are better investors than we are.

Some sobering truths:

We are hard-wired to be overconfident, attribute our successes to our skills and failures to outside forces, and tend to rewrite our own history to make ourselves look good. And even when we are rewriting history or blaming outside forces, we are still likely to miss signs of our own incompetence.

Read more: Why we think we are better investors than we are (New York Times)

Nobel Prize-winning psychologist Daniel Kahneman has found that a loss yields roughly twice the psychological effect of an equivalent-size gain ?which means that if you look at the stock market every day, you are likely to feel a lot of pain.

But despite this pain and these poor odds, we still try to time the market and pick winning stocks. Perhaps it just feels too good to be right. We are wired to love it. Winning money activates dopamine. The more dopamine firing in our brains, the more pleasure we experience. Cocaine is dangerous because it directly increases dopamine levels.

Read more: Dope, Dopes, and Dopamine: The Problem With Money (Harvard Business Review)

Greed, overconfidence and our primitive human shortcomings are dangerous for investment performance. You are probably asking yourself - well, what can I do about it? Stay tuned.

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