Not rebalancing your portfolio regularly – legacy baggage. Being attached to certain stocks, especially if they have made losses.
It is only human and natural to become attached to what we own.
This is especially true if that asset has brought us joy or profit.
When it comes to financial assets though, even if the asset has made a loss, there is sometimes a need in us to hold on to it, till it becomes profitable again. This may be because we don’t like to admit that we made a wrong decision.
We call this phenomenon “legacy baggage”.
This behavior is simply evidence of our innate tendency for biases and misjudgements.
And it affects even professional fund managers, whose portfolios tend to perform best in the first couple of years of formation, but struggle in later years.
The solution: Have a strict regimen of regular periodic rebalancing. What that means is, we reset our portfolio to the allocation percentages that we had agreed upon in our investment plan, no matter whether the market or portfolio components are up or down. Our aim is to remove the effect of our emotions that skew our thinking and actions.
Trying to go after every last penny, a.k.a. the crumbs on the floor. In other words, “penny wise, pound foolish”.
Going after every last dime and dollar in every situation is not something that we usually do knowingly nor purposely – if we do, then we need to start working on changing this attitude. Indeed it is childhood conditioning: many of us have been taught by parents and society to “value each dollar”. So it is quite human to “leave no crumbs on the table”, “wipe the plate clean”, and let nothing go to waste. But this habit of ours reveals a very big, and costly, cognitive dissonance. And that is, whether we are able to give exactly proportional attention to different amounts of money. For instance, would a loss of $10,000 affect us exactly 10-times more than the loss of $1,000? For many of us, the answer would be, “not exactly”. We are often proportionally more attached to smaller amounts than larger ones. This is also because our organic brains rarely process information like an unemotional, ever-rational computer would. In the context of investing, this condition shows itself when the investor is waiting for the absolute lowest price he/she has in mind to buy an asset (a few percentage points off won’t do), and the highest price to sell it.
Being afraid to make mistakes
To pick up a new skill, we usually have to be prepared to not do it right the first time, or tenth or fiftieth time in some cases – be it learning to ride a bicycle, playing a musical instrument, or sales excellence. The key in each of these endeavors is that the “mistakes” are an essential part of the journey. Well-rounded maturity in any field happens only when we have experienced failures along the way. But, we should never put too much at risk. That’s why when learning to drive a car, the instructor will always be beside you – ready to grab the wheel and avoid costly accidents. That applies to investing as well. We need to start thinking like scientists. We test the best of our knowledge with relatively small amounts of our money – something that we can easily recover from losing. With this strategy, we win both ways – either financial profits or valuable insights that we can include in our next decision.