Do You Love Your Investment Holdings?

Consider your investment portfolio. Do you hold stocks (or other securities) in companies that you love? Do you tend to disregard or ignore articles that highlight the bear case for that investment? If yes, you could setting yourself up for a common pitfall when it comes to investing. Falling in love with an investment is one of the worst things an investor can do for overall returns. As humans, it is in our nature to like/love things that are familiar to us. This is not just applicable to stocks or investments, but for everything in life.

I was recently listening to the Masters in Business podcast with Daniel Kahneman. Daniel Kahneman is a world renowned psychologist, best known for his work on the psychology of judgement and decision-making. Even though he is a psychologist, he is a Nobel prize winner in economics (awarded in 2002). His research explained and shed light on why the investing world falls for the same traps over and over. One of his most cited study is the Prospect Theory, which among other things summarized that humans value gains and losses very differently. Losses have a far more emotional impact than equivalent amount of gains. For e.g., losing $5 has a stronger emotional impact on most people than finding $5. The overall psychological impact is charted as shown below from the Kahneman & Tversky study. As noted, the curve falls faster towards the left than it rises on the right, indicating the overall psychological impact.

prospect-theory

I highly recommend you listen to the podcast, but if you do not have the time or patience, have a listen starting at the 41:45 mark. As Prof. Kahneman explains, the familiarity of ownership makes humans think highly of that entity. In his words, “Almost everything that is familiar….you like better”.

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