We are all a bundle of hundreds of hard-wired behavioural patterns that have successfully kept our genes alive since Adam underwent a bit of surgery. This means that our monkey brain decides to do many things without us really thinking about them: at best we rationalise an ex-post semi-logical explanation. I talk from experience.
Because we are generally unaware of there behavioural responses (or 'bias' to give them their more formal name), they are very powerful - and can be used against us quite successfully (think of any breed of salesman). At the very best, we can hope to recognise the patterns and adopt some kind of strategy to minimise their influence - because it's not like you can turn them off.
One of the strongest behavioural quirks in investing is 'loss aversion': being happier to risk a profit rather than an equivalent loss. I suffer from this but try to keep it under control through various strategies and investing 'rules'.
Sometimes that doesn't quite work. Take my holding of FirstGroup (LSE:FGP) the UK public transport operator, also big-ish in the US. [Don't you just love the creative punctuation - I wonder how much it cost to lose a space and go from 'First Group' to FirstGroup]
Here is the story:
- April 2010: big operation, attractive yield - buy @ 367p
- Yield and share price plummet - oh dear, but keep holding on...
- July 2013 (three years later!): situation improving - double up by buying @ 85p
- March 2014: share price is around 138p
What can I learn from this?
- First, this investor really doesn't like to sell his losers. Watching a falling price over three years doesn't look like much fun.
- Second, FGP didn't go bust (yet) - if the price recovers to the point where the capital loss is wiped out, the overall cost will be the opportunity cost of lost income for a couple of years.
- Third, the return on the July 2013 purchase is over 60%. Not enough to wipe out the loss of the previous poor purchase but still one of the best returns I have been able to hold onto without selling. Had it been a stand-alone purchase I would in all likelihood have cashed in my chips already,
For me, the interesting feature is that by doubling up in 2013, it seems to have dealt with two aspects of loss aversion at once:
- as the share price rises, I feel less bad about the initial purchase decision (and the capital loss)
- but because the total investment in FGP is still showing a capital loss, I don't feel the urge to grab an early profit from the 2013 purchase
So, who's fooling who(m)?
I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.