'Tendency to sell winners too early and hold on to losers too long'
Generally, people are inclined to sell investments that have produced strong returns, but hold on to investments that have performed poorly. There is a logic to this: Once you sell a poor investment you've realised a loss, but up to that point there is still the prospect that the fund could recover. Equally, realising a gain is attractive because there's always the possibility that the gain could be lost if the fund performs badly.
Watch out for this bias and try and steady clients to take objective decisions. Counter their desire with facts:
- A US study showed that this bias can harm returns. The study found that the average return of "winning" stocks that investors sell was 3.4% higher than the average return of the "losing" stocks they hold on to in the following year.
- Many people sold Google shares at the IPO price of US$85 and will have doubled or trebled their money. Yet 10 years later the price had risen 1,500%!
- Remind clients that the natural conclusion to this strategy is that you can end up with a portfolio of poorly performing funds (having sold all the funds that perform well)!