The top investor mistake
One of Nadler’s early investments was about $800 to $1,000 of stock in technology company Nvidia, which he bought in the “low single digits.” Before 2014, the shares had earned a decent profit so he decided to sell a large chunk of his holdings. It turns out that this sale gave Nadler lots to talk about with his students — since it was a big mistake.
His brokerage says the original price he paid for the stock, considering the stock splits that have taken place since, was about 48 cents. Nvidia is currently trading close to $150 a share and its value increased by over $2 trillion just last year. If he’d held onto the stock, his gain would have been over 30,000%. The value of his holdings would have been “enough to buy a nice house somewhere,” according to Nadler.
Nadler sold the stock because he succumbed to a cognitive bias known as loss aversion. A cognitive bias is a consistent, repeated error in the way we process information and perceive reality. Loss aversion is a common cognitive bias that leads us to perceive losses as more significant than gains.
You can judge your own loss aversion by considering whether you’d rather have $100 or flip a coin to gain $200 for heads or $0 for tails. Most people would prefer the certain $100 and value the potential “loss” of this as greater than the potential but uncertain gain of $200. Then consider the coin toss with a payout of $500 or $1,000. At what value would you decide to take the risk of a higher payout versus the certain amount? This gives you an idea of how risk averse you are.
In investing, loss aversion can cause us to fear losing the gains of a winning bet in our portfolio. This is what happened to Nadler. As he tells it, “What was going through my head was, ‘Hey, I’m new with this. I just made a significant profit in a very short amount of time. I want to lock it in because I’m feeling afraid it may drop again.’”
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Learn MoreHow loss aversion is driving your investment decisions
Not holding onto gains, being too conservative in your portfolio construction, trying to time your entry into the market or moving to cash to avoid volatile markets are all results of loss aversion — and can all hurt your portfolio. Research has shown that trying to time the market is costly and time out of the market can dramatically reduce your returns.
Avoiding this cognitive bias means carefully evaluating any sales, especially if you plan to move to cash, and trying your best to remove emotion (such as fear) from the decision. For instance, if you’re planning to sell a stock because it’s had a strong run, but fundamentals suggest it’s still a solid investment, you may want to step back and evaluate whether you’re making a rational decision or being driven by fear.
Engaging a financial adviser could potentially help you manage that fear by providing an arms-length assessment of your decisions. An adviser could also help you set realistic investment goals so you’re not relying on “bets,” and help you diversify your holdings to spread your risk and make individual risks within the portfolio feel less intimidating.
Increasingly, there are also technological tools available to help you remove emotion from investment decision-making. For instance, Nadler founded Prof of Wall Street, which provides software products that help investors use behavioral science to manage biases and improve investment decision-making.
Fear can be a powerful force. Identifying it and enlisting the help of a financial adviser or technological tool could help to take the cognitive bias out of investment decision-making and, hopefully, result in better returns.
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