Selling at a loss and the psychology of investing

One of the most challenging aspects of being an investment advisor is understanding and working with the psychological aspect of investors holdings.  Often, an investor will come to me and need help with their investment portfolio.  They usually understand that they need help, but often they are reluctant to sell investments they have been carrying for some time at a loss.  One of the common investment maxims of tenured investors is "let your winners run and cut your losses" which may or may not be correct, but nevertheless, our brains seem to be wired up in exactly the opposite way.  Some examples help to illustrate this.

If someone offered you either $100 with no strings attached or the option to flip a coin for the chance of winning $200 or nothing, which one would you choose?  Mathematically they are exactly the same but most people choose the $100 guaranteed.

On the other hand, you could either lose $100 for sure or flip a coin for no loss or a $200 loss.  In this instance, almost everyone chooses to flip the coin.  People would rather risk a larger loss than bear a guaranteed loss, but would take a guaranteed return over a volatile return.

This happens all the time with investors.  This week, I sat with an investor and we determined that his current portfolio had almost no hope of good performance.  I suggested he move his portfolio to something that looked like it should perform very well over the next several years.  Even though he agreed with me, he decided not to move his portfolio because "it just felt like too much of a loss".

We all have emotional issues about investing but it is always important to remember, you can't change the past.  All you can do is the best with what you have and move forward.