Are you suffering from Loss Aversion Bias

 "We find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding." - Warren Buffett

Any investment that you make has essentially two outcomes. Either it will succeed or it will fail. 

Of course whether it will succeed or fail depends upon the kind of effort one puts in to know the business and fundamentals of the company. The price at which one buys is also equally important.

Despite being cautious and following a long term approach to investing there could be some rotten apples in your basket. In other words, companies that fail to deliver as per your expectations. 

Now what should one do in such cases? 

Obviously the answer is 'Sell the stock'. However, that is easier said than done.

There is a general tendency amongst people to hold on to underperforming stocks. Basically they hold on to these losers for long until the stocks decay. 

This unwillingness to exit bad stocks is called 'loss aversion bias'. 

The very thought of exiting the stock instills a fear of regret in investors. The regret pertains to making a wrong investment decision and losing money. It is an emotional trap. 

In short for emotional reasons, many do not have the courage to book loss on a poor investment decision.

However, investing is not just all about fundamentals, valuations and businesses. It is also about emotions. This is because we as human beings take the buy and sell decisions. Our decisions are governed by our emotions. 

Thus, apart from having a strong knack to understand businesses having a strong emotional intelligence quotient (EQ) is equally important to be successful in investing.

One who can block out his emotional side and take rational decisions based on the facts presented will more often than not end up on the right side of the coin.

Take the case of holding on to losers for long mentioned earlier. If one were to purely evaluate the company on the basis of its fundamentals, keeping emotional biases aside then taking a prudent exit decision will not be difficult.

Apart from not allowing investors to exit the losers, emotional biases also induce investors to sell winners too soon. How many times have you exited the stock after registering a minor gain and later see the stock rally further?

While it is fundamentals that decide what businesses to buy and sell it is our emotions that decide when to buy and sell. 

One who can balance both is on the right path.



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