This is one of the most common investor mistakes

by , 30 October 2017
This is one of the most common investor mistakes
Today I want to explain one of the biggest mistakes investor's make.

It has nothing to do with what you invest in, where you invest or how much you invest. It goes much deeper than that.

It's got to do with your emotions and behaviour.

The fact is, every investor experiences it at some point. And if you keep doing it, you're guaranteed to lose a fortune.

Let me explain…
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Revealed: The worst thing you can do as an investor

You see, as humans, we feel the pain of loss more intensely than we feel the pleasure of gain. Quite simply, we may like to win, but we hate to lose.

In fact, It’s a well-known phenomenon and what behavioural finance terms "loss aversion".

Loss aversion was first described in the 1970s by psychologists Daniel Kahneman and Amos Tversky.

The pair did a study: They tossed a coin and if it landed on tails, the person would lose $10. But they also asked the person, how much would you have to gain on winning for this gamble to be acceptable. The thing is, people wanted more than $20 before they accepted the challenge.

It’s the same when it comes to investing. Investors are more likely to sell winning stocks to lock in profits, while at the same time not wanting to accept defeat in the case of their losers.

One of the most influential investors of all-time, Philip Fisher wrote in his timeless book Common Stocks and Uncommon Profits, "More money has probably been lost by investors holding a stock they really didn’t want…than from any other single reason."

That’s why I’m going to show you two investment tools you can use to combat “investor loss-aversion”.
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Two investment tools you can use to avoid “investor loss-aversion”

You can easily avoid loss aversion by using stop losses and position-sizing.

#1: Stop loss: This is an important tool you use to limit your losses when buying shares. It helps keep your emotions from interfering with your decisions. They also protect your investment from massive falls in the market.

Let’s use my friend ‘A’ as an example: Initially he was doing extremely well on his stock picks. In total, he had notched up gains of 36%, 57% and 80%. But the markets took a turn for the worst.

‘A’ failed to do one very critical thing as he kept racking up gains. He failed to protect his gains and prepare to prevent any losses.

#2: Position-sizing: This is a useful tool to limit the amount you put into each stock. A golden rule is to never invest more than 5% of your portfolio in one stock.

For example: ‘A’ had invested a portion of his money in UK and European stocks. For a while, his stocks were consistently performing. But after Brexit, when the markets sank, ‘A’ lost nearly 50% of the value of his offshore positions.
But he could’ve prevented this huge fall.   
Instead of ‘A’ rebalancing and selling a portion of his UK and European stocks, so that it would represent 5% of his portfolio again, he let them ride. And when the markets fell, his portfolio fell with it.

However, the fact is, avoiding losses is impossible to do... Even the best investors have lost a fortune. The key is to learn how to limit your losses and avoid the paralysis of loss aversion. And the easiest way to protect yourself is to stick to simple investment tools like I've outlined, no matter what.
Always remember, “Knowledge brings you wealth”

Joshua Benton
Editor, Real Wealth

This is one of the most common investor mistakes
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