Ease up: even the experts find it difficult to re-balance their investment portfolios
December 17, 2013 by Editor, InvestingForMe
As an investment advisor I’ve spent years taking courses to learn about managing investments through designing, monitoring and managing diversified investment portfolios. And I’ve spent decades helping individuals plan, save and invest for their futures. I’ve enjoyed the ride in some really great stock markets and I’ve also endured some really horrendous ones. So, no one understands better than I do the dire need for smarts and sound logic around re-balancing an investment portfolio on a regular basis. But even with all of my experience and understanding I still don’t find it any easier to actually pull the trigger and sell, which is what re-balancing investments is all about – the decision to sell.
Selling and re-balancing: not for the weak of heart
When it comes to deciding when to sell and re-balance your investments, you really have to look in the mirror and know when it’s time to do the right thing. Deciding to sell is the ultimate emotional decision when it comes to your finances and probably the most difficult investment decision you’ll ever face. Why? Because it brings you face to face with those two killer emotions – greed and fear. You feel greed because you can’t bear the thought of the investment’s price going up after you sell, and you feel fear about not selling and having the investment price drop and risk losing more money. Yikes!
But the decision to sell, however, is a little easier if you’re trading in the privacy of your own account where no one else knows what you’ve sold or not sold and can’t make any judgement calls (except for the guy in the mirror!).
Now, imagine the fear if you work as an investment advisor or you publish investment advice giving buy-and-sell recommendations? Well, you face a tsunami of emotions – not just your own fears and greed, but the fear and greed of your clients and readers who always have the benefit of hindsight and long memories. It’s not always fun, let me tell you!
How to avoid re-balancing under the influence … of greed
Have you ever purchased a lottery ticket? Ever gambled at a casino? Ever bought a flyer of a stock? All of these purchases carry a very high probability that you’ll lose your money. But so many of us do it anyway! If you knew your chances of losing your money were higher than winning, why did you buy?
For the simple reason that you couldn’t pass on the opportunity to win big! You threw logic out the window and risked losing your money in the off chance that you could buy and score big money. In other words, your greed overcame your fears.
It’s not very smart. And greed is not restricted to gamblers. It’s also a major hurdle for conservative investors and the rebalancing of their investments. For example, let’s say your investment in that big bank’s stock is up 200% and now represents 35% of your portfolio. So you know you should sell some or all of the investment to re-balance that single investment to a smaller percentage. Logically you know that’s the right decision! But your greed counters your logic by asking you one simple question – What if you sell and the shares go up? You’d miss out on that increase! You’d lose money!
It’s at times like these that you have to ignore that greedy little voice inside all of us. Yes, you could wait and win big, but you might not! You might lose big! It’s smarter to take some winnings home than none at all. The right answer is to sell and re-balance, and forget about the what-ifs. As the old saying goes, you’ll never go broke taking a profit!
Remember: When it comes to investing, greed can unfortunately make us twist our fears around to get us to mistakenly think a missed investment opportunity is the same thing as losing money – when it’s not. You have to learn to do the right thing and re-balance at those key moments when it comes to investing in order to come out a true winner in the long run.
Fear can also sway you off track
On the other hand, when it comes to selling your investments your sense of fear can also make you do silly things. There are two types of fear an investor can face – the fear of regret and the fear of loss.
We have all experienced the fear of regret. Have you ever bought a product or investment only to see the same thing selling for a lower price a couple of weeks later? Have you ever sold something and then learned that you could have sold it for more? Did you feel a bit of regret? Maybe even a bit dumb? If only you had waited two more weeks!
No one likes to make a decision that with Monday morning quarterbacking might not appear so great. For investors, this fear is very real and can impact their decisions to buy and sell an investment. This fear of regret, as it’s often called, can also prevent you from logically re-balancing your investments at the appropriate times. This means typically selling a winning investment and re-investing the money in another investment. But your fear of regret is twice as great if the winning investment you sold keeps going up and your new investment goes down. You’re left asking yourself why did I sell? Why did I buy? How stupid! The proven logic of re-balancing and securing investment profits is under constant threat when your fear of regret teams up with your greed.
When faced with the re-balancing decision, investors must battle another very potent fear – the fear of loss. This is a big one! And every investor has a fear of losing money, where some have it bad, while others not so much. We’re all different and yet we’re all driven by it to some extent. The trick is to not let your fear of loss get in your way either (like greed!) and stop you from selling and re-balancing your portfolio when you need to.
A number of psychological studies have demonstrated that in general investors hate losing money twice as much as they enjoy making money. This relationship will often lead investors to refuse buying an investment if the probability of losing a dollar equals the probability of making a dollar. And this relationship of fear over greed can also influence our decision to sell an investment if it means we might miss out on future gains. In other words, in order for our greed to override our fear of loss, the promised returns must be greater than twice the potential losses.
Conclusion: battle it out with the guy in the mirror and do the right thing
So what does all this talk about fear and greed mean? Well, when it comes to re-balancing my own personal investments, I’ve grown accustomed to the fact that investment decisions (i.e. to buy, hold, or sell) will always have some element of fear and greed, but over the years I’ve become much better at battling my fears and greed, which means I’m better at recognizing when it’s time to re-balance and making the necessary changes logically without emotion. And I’m much more forgiving of my past decisions. After all, I’m only human.
Click to read the first article in this series - Conservative investor or aggressive trader – which one are you?