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Hanging onto Disastrous Investments

jeroen blokland
Seasonal Investing
February 20, 2019
cruise line investment
Travel and Tourism, Tantalising Investments
May 22, 2019

WHY DO INVESTORS HANG ONTO DISASTROUS INVESTMENTS? TRANSFIXED IN THE HEADLIGHTS!

There is a strange psychology surrounding investors reaction to the phenomenon of falling share prices. Let’s start off by looking at the classic case of Steinhoff.

In the glory days of Markus Jooste, spending twenty million on racehorses in a single day, the share price approached one hundred rand.

Then came the shocking revelations and in a short space of time the share price collapsed below fifty rand. So many investors bought on the way down and more bought at below fifty. Thousands of shareholders just kept the shares they already held. Steinhoff was a most widely held share.

I personally know of investors who started buying as the shares fell. Some bought at below twenty, some at eight rand and some at four rand. Since the collapse fifteen months ago I still see new portfolios which still hold Steinhoff shares. At the time of writing this article Steinhoff was trading at R1.88.

More than 250 billion rand has been lost. Half of this loss could theoretically have been avoided if investors had sold out on the way down. (For the record: Fenestra Asset Management had no shares in Steinhoff).

When I ask these new clients why they didn’t sell Steinhoff you get the following answers: “How much lower could it go?” “It has already fallen so much, it has to turn soon.” “I could never sell it at such a loss”. “I can’t sell it so low” etc. What these investors need to realise is that what you paid for a share has absolutely nothing to do with its future value.

This “disposition effect” is the habit of investors to sell brilliant shares and keep bad ones. The historical cost is just that. History! Value is about the future.

A behavioural economist will tell you that many investors have a cognitive bias for loss aversion. This bias obviously results in emotional and bad decisions and results in investors holding onto a losing investment long after it should be sold. These investors make the mistake of hoping a stock will bounce back, against all evidence to the contrary, because the loss leads to a more emotional response than gains.

And according to prospect theory people strongly prefer avoiding losses than acquiring gains. This aversion even goes so far as leading to a negativity bias where investors only focus on bad news leading them to avoid or not see great investments.

Investors need to understand behavioural finance. You need to be ready and able to capitalize on stock market fluctuations.

On a positive note losses can have a huge value if you learn from them. Work out what went wrong and understand your own “loss psychology” and move on. There are so many opportunities out there.

As the cartoonist Walt Kelly wrote for the first Earth Day in April 1970: “We have met the enemy and he is us” or as the founder of modern portfolio management Benjamin Graham said: “The investor’s chief problem – and even his worst enemy – is likely to be himself”.

So ignore the disposition effect and cut your losses short and let your winners run!

If you are not happy with your portfolio performance or would like a second opinion, please do not hesitate to contact Fenestra for a free, independent, objective and confidential review of your portfolio.

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