Every Investor’s Worst Enemy
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Warren Buffet’s number one rule of investing is simple: Never lose money. His second rule? Never forget rule number one.
At some point in our investing journeys, we all break this rule (probably more than once). Don’t tell Warren, but I’ve personally broken it four times, and it never feels good.
Source: My Sold Positions | My FREE Portfolio Tracking Spreadsheet
Realizing losses on an investment is probably the worst feeling an investor can experience. When you’re still holding a losing investment, there’s at least hope that you can make your money back. But once you lock in those losses, that hope is gone.
Maybe that’s why Buffett’s rule is so important. Losing money not only defeats the purpose of investing, but it also feels awful.
There’s a psychological concept called Loss Aversion that explains this. It’s a common theme in investing and refers to the fact that losing money feels worse than making money feels good—something rooted in our neurological makeup.
In the context of investing, loss aversion helps us understand two other, related bugs in our human software: the Endowment Effect and Status Quo Bias.
The Endowment Effect occurs when sellers place a premium on an asset they own, valuing it more than its worth due to their emotional attachment.
This bias is extremely common in real estate, where homeowners often want to overprice their homes. Because a home is such a personal and sentimental thing, the seller sees their home as more valuable than it might objectively be, leading to inflated asking prices.
The same thing happens with stocks. You might unknowingly overvalue a stock that you own, believing it has more potential or worth than what others think, simply because you possess it.
Sometimes, this mindset is necessary because investing inherently involves a degree of arrogance. The act of buying a stock essentially means you’re saying, “I am right and the person selling it to me is wrong.” You’re betting that the market has undervalued the stock and that your belief about its true value will eventually be proven right.
On the flip side of that, you might also be hesitant to sell a poor performing stock. You may hold onto it longer than you should because you feel a sense of ownership and attachment, convincing yourself that the stock will rebound despite evidence that might indicate otherwise.
This attachment can cause you to lose more money than you should, and can cause you to miss out on better investment opportunities. You might refuse to sell a stock that has sentimental value or has been in your portfolio for a long time, even if other stocks offer better return prospects.
If you’re afraid to sell a stock simply because you’ve owned it for so long, you might be suffering from Status Quo Bias. This is the preference to maintain your current state of affairs due to a fear of change.
As an example, consider an employee who has been with the same company for many years despite better job opportunities elsewhere. The employee may fear that switching jobs could lead to an undesirable outcome, such as a less favorable work environment—which, to be fair, is a legitimate fear. Here, the potential downsides outweigh the possible upsides from a new opportunity.
With investing, Status Quo Bias might cause you to stick with a stock you own, even if the business is in decline and potentially better opportunities present themselves.
At the end of the day, both the Endowment Effect and Status Quo Bias tie back to loss aversion. Whether it's overvaluing what you own or being afraid of change, your decisions are often driven by a desire to avoid losses rather than achieve gains.
Sometimes, we can be our own worst enemies. Our biases, whether we want them to or not, significantly influence how we manage our investments and make decisions in our portfolios. While we can’t always overcome these biases, we can at least be aware of them to hopefully make better investment choices.
With that said, I want to hear from you: Have you ever held onto a stock longer than you should have? Reply to this email, or write to me here and let me know.
And a big thank you to all of the readers who responded to last week's newsletter! You can read some of the responses down below in the "Hot Takes" section. 👇
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SINCE YOU ASKED 💬
"If you had to pick only 3 stocks to hold for the next decade, what would you choose and why?"
- Cyclone Craw X | YouTube
This is an extremely difficult question for a couple of reasons. First, it's tough to narrow it down to just three stocks. Second, it's impossible to predict the future. I have no idea what's going to happen over the next decade.
Because of that, my approach for answering this question is to consider the stocks I think are most likely to survive whatever could happen over the next 10 years. I ask myself: If the stock market closed for 10 years and I couldn't make any changes to my portfolio during that time, which stocks would I want to have locked away? Here are my three picks:
Visa (V) - Visa is the world's largest payment network, by far. As time goes on, people will use cash less and less to pay for things, which only stands to benefit Visa. I believe this transition to digital payments would continue even if the stock market closed for the next decade, and I think my position would be worth more 10 years from now than it is today.
Proctor and Gamble (PG) - Over the next 10 years, people will continue using necessities like toothpaste, toilet paper, laundry detergent, deodorant, and all the other household essentials that Proctor and Gamble makes. As a result, I think PG will be a pretty safe hold over the years, and I have a hard time seeing their 65+ year dividend streak ceasing over the next decade.
Chevron (CVX) - The transition to renewable energy sources will be a multi-decade process. In the meantime, energy demand continues to grow and will likely do so over the next decade. This serves as a strong tailwind for CVX and related companies, making it a reliable investment for the coming years.
Have a question? Ask me here to see it featured in an upcoming newsletter.
HOT TAKES 🔥
Last week, I asked readers about the last stock they sold out of. Here are some of the responses:
Matt said: The last stock I sold was actually today with KVUE. I did it because it was 30% down on price, looked like they had stagnant growth and rising debt, and I wanted to reuse the funds to buy more PEP, MSFT, UNH, and of course SCHD.
James said: I recently sold out of SPXC, TSLA, and VZ. The reason I sold out of VZ is because I lost faith in the company and look at debt along with dividend safety it just felt odd holding onto it. SPXC I recently had 1 share bought in at $72.74 and cashed out at $145.70 which is a 100% gain on the investment. I didn’t want to let greed get me so I figured It was time. TSLA I actually wanted to hold onto my 6 shares I had at $241.99 per a share but overall the longer I held onto it the less I felt good about it. Something was telling me with good earnings it was time to dip. I did cash out at $250.00 per share so nice gain on that.
Pat said: I sold out of Albemarle (ALB) when it became clear that lithium's day was a few years away, and it might not ever have its day based on the steep innovation curve the battery world is going through. I collected 1.5 years of dividend payments, but bought ALB at $220 and sold it at $130. Ouch!
Rupesh said: Such a coincidence. It seems I have started thinking like you while listening to your channel. I also sold AAPL and KO today, and added that money to V. I did not make anything on KO, but made 35% on AAPL.
Chad said: The last stocks I sold out of were ARR, DISH, and a bond ETF. All 3 had lost money over the term I owned them and weren't showing anything positive to the contrary. I had purchased all 3 at the very beginning when I was a bit more ignorant.
