Why hang on to disastrous investments?

Your Share of the Pie

By William Meyer

There is a strange psychology surrounding investors’ reaction to the phenomenon of falling share prices. Let’s start off by looking at the classic case of Steinhoff.

In the glory days of Markus Jooste, spending R20 million on racehorses in a single day, the share price approached R100.

Then came the shocking revelations and, in a short space of time, the share price collapsed below R50. So many investors bought on the way down and more bought at below R50. Thousands of shareholders just kept the shares they already held. Steinhoff was a most widely held share.

I personally know of investors who started buying as the shares fell. Some bought at below R20, some at R8 and some at R4. Since the collapse fifteen months ago, I still see new portfolios which hold Steinhoff shares. At the time of writing this article, Steinhoff was trading at R1.88.

A great deal of the losses due to Steinhoff’s share crash could have been avoided by investors.

More than R250 billion has been lost. Half of this loss could, theoretically, have been avoided if investors had sold out on the way down. (For the record, Fenestra Asset Management had no shares in Steinhoff).

Now read: Take the long-term route to beat the blues

When I ask these new clients why they didn’t sell Steinhoff, I get the following answers: “How much lower could it go?” “It has already fallen so much, it has to turn soon.” “I could never sell it at such a loss”. “I can’t sell it so low” etc. What these investors need to realise is that what you paid for a share has absolutely nothing to do with its future value.

This “disposition effect” is the habit of investors to sell brilliant shares and keep bad ones. The historical cost is just that. History! Value is about the future.

To avoid undue suffering, investors need to understand behavioural finance. ‘You need to be ready and able to capitalise on stock market fluctuations.’ Picture: Nik Shuliahin/Unsplash

A behavioural economist will tell you that many investors have a cognitive bias for loss aversion. This bias obviously results in emotional and bad decisions, and results in investors holding on to a losing investment long after it should be sold.

Bounce back

These investors make the mistake of hoping a stock will bounce back, against all evidence to the contrary, because the loss leads to a more emotional response than gains.

And according to prospect theory, people strongly prefer avoiding losses than acquiring gains. This aversion even goes so far as leading to a negativity bias, where investors only focus on bad news, leading them to avoid or not see great investments.

Investors need to understand behavioural finance. You need to be ready and able to capitalise on stock market fluctuations.

Loss psychology

On a positive note, losses can have a huge value if you learn from them. Work out what went wrong and understand your own “loss psychology”, and move on. There are so many opportunities out there.

As the cartoonist Walt Kelly wrote for the first Earth Day in April 1970: “We have met the enemy and he is us”, or as the founder of modern portfolio management, Benjamin Graham, said: “The investor’s chief problem – and even his worst enemy – is likely to be himself.”

So ignore the disposition effect and cut your losses short and let your winners run!

If you are not happy with your portfolio performance or would like a second opinion, please do not hesitate to contact Fenestra for a free, independent, objective and confidential review of your portfolio. Contact info: 079 624 4031. fam@mweb.co.za