In my last post I had discussed about how it is important to suppress one’s ego to become a better investor and why more money has probably been lost by investors holding a stock they really did not want until they could “at least come out even” than from any other single reason.
Let’s now look very simply at how we can be more rational in our decision making and though process about bad investments.
Assume yourself to be an investor who has invested 1 lakh in Stock A at Rs 100 based on certain level of due-diligence. As time passes you carry out more research on the stock and find some uncomforting details about the company, management, etc. Meanwhile, unfortunately for you the stock has also corrected by 15% and your investment is down to Rs 85,000.
How do investors deal with such a situation?
Some just do nothing, rather pray and wait for the stock to rebound back to Rs 100, forgetting completely the fact that if there are certain issues in the company, the likelihood of stock falling further to 80, 70, 60 levels is more than rebounding back to 100. As mentioned above, “at least come out even” has resulted in substantial erosion of wealth for the investors.
There are others who go one step further and throw good money after bad in their bid to lower their average purchase price. Here again the thought process is similar, i.e. “at least come out even” and speed up the process by lowering the average purchase price. It’s basically a case of ego being inversely proportional to rationality.
In my view, the rational way of dealing with the situation is that you should ask yourself certain questions; they are:
Would you rather have Rs 85,000 invested in Stock A which you are not confident about or have Rs 84,700 (assuming 0.3% transaction cost) cash which you can ably deploy in a good stock you are confident about?
Basically, the purpose of the above question is to get over the anchoring bias of Rs 1 lakh (the initial investment) and think in terms of the current available options of 85,000 in not so good company Vs 84,700 free cash.
Do not let your ego and ~0.6% transaction cost (~0.3% for selling and similarly for buying) impact your decision making. Besides monetary gains, there are intangible gains in the form of lower stress as owning something which you are not sure of can be very stressful.
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