This week we are going to discuss the delicate issue of emotions in relation to investing. It is easy for, us, as investors to become emotionally involved in our investing decisions, but we must try to separate the two as much as possible. We will discuss the various methods one can insert into his or her investing style in order to help curb this problem we will all face one time or another.
It is quite easy to become both fascinated and greedy in owning a particular stock, and it is this emotion that in the end can cost you lost profits and deeper losses. Take the following example for instance, where one buys a company that has extremely positive outlooks and the stock rises. The investor declines to take his short term profits now that the security is overpriced and the stock declines back to a more reasonable level. The investor in this scenario has left profits on the table, and reduced his overall rate of return for his portfolio. It is naïve to believe that it is simple to sell when a stock is riding high as you are always in anticipation of further gains. What one needs to develop is a set of guidelines that guides them in their investing decisions.
My personal investing guideline is as follows: my risk tolerance on the downside is no more than a 10-12% loss, and my upside tolerance is 12-15%. These prices are obviously above the appropriate price level, determined by my personal valuation models. This will vary from person to person, but personally I feel this protects me and at the same time allows me to maximize profits. I re-evaluate my portfolio monthly looking for any stock that falls outside of these parameters and then I check to make sure there are not any extenuating circumstances that justify being outside the lines. This entire model of evaluation is obviously not as cut and dry as it seems, there are times where I may accept further temporary losses, or lower positive gains, if I feel there are just reasons.
Do not be afraid to sell, that is the most difficult aspect of investing! Everyone holds onto stocks too long hoping they will rebound, but it takes a disciplined, prudent investor to recognize gains that are out of line and capitalize on those. Greed can ruin a portfolio so try to avoid this basic human instinct at all costs. As Michael Douglas states in “Wall Street”, “greed is good”, he is missing the point that greed can cause more harm than good in the long run. Try to adopt an investing strategy and stick to it, and I promise you that you will never be disappointed in the results it will generate.