Three Ways to Stop Making Emotional Investment Decisions
by Marc Lichtenfeld, Advisory Panelist
Thursday, September 3, 2009: Issue #1083
"You think they're your friends, but they're not your friends."
This was the frequent refrain from a landlord I had while in college. He was warning us on the danger of throwing parties and inviting people who we considered friends, but would think nothing of trashing the place.
I guess it's not surprising that renting his house to college kids made him a little paranoid. He often showed up at random times to make sure there was no revelry taking place. Once, he chased away some of my buddies as we were watching "Monday Night Football" (I guess the keg in the corner didn't help our argument).
This no-nonsense, unattached attitude is the perfect way to approach the stock market and your investments. After all, most investors have had stocks that we thought were our friends, but that ultimately turned on us and caused pain.
The trick is to not become emotionally attached to them.
This is easier said than done, so if you find yourself hanging onto stocks for too long, or investing more with hope and emotion than sound reasoning, allow me to give you some tips...
When it Comes to Emotions, Adopt DeNiro's "Heat Mentality"
I was fortunate that my stock market education started at a trading desk, where we executed trades according to how the market and stocks were performing. Period. Nobody cared if the stock had a low P/E ratio... whether the company had the next great biotech drug... or was run by a terrific management team.
To us, stocks merely represented three or four letter symbols. That's it. In some cases, I didn't even know the names of the companies and couldn't have told you much about their businesses.
Sounds a bit clinical, doesn't it?
It was. And it served me well. I learned that you shouldn't get emotional about stocks. They're simply investment vehicles in which to park your money. Granted, you can be in a stock for five minutes or 20 years, but you should never form a relationship with them.
As Robert De Niro's character said in the movie, "Heat": "Don't allow yourself to get attached to anything you cannot walk away from in 30 seconds flat if you feel the heat around the corner."
Think about it. Many of us have owned a favorite stock - perhaps for years. Oftentimes, the longer you hold it, the more difficult it can become to sell it - even when you know you should.
We form an emotional attachment to the business that often has nothing to do with how the stock is performing - or how much money we're losing from it.
This can be an issue, particularly in the biotech and health care spaces ...
It's Easy to Form Emotional Attachments to Early-Stage Companies
One of the key price catalysts for a biotech or health care company is when a medical advancement is made. For example, a new cancer drug is approved, a company sees strong clinical trial results, etc.
Not only are we happy that our investment is worth more, but we also feel good about being involved with a company that saves lives or alleviates suffering.
For that reason, some investors form particularly emotional relationships with early-stage companies that show great promise.
In The Xcelerated Profits Report, I recommended Medivation (Nasdaq: MDVN). The company is currently developing one of the most promising drugs to combat Alzheimer's Disease - Dimebon.
When I made the recommendation in August 2007, I believed Dimebon would work and that the potential reward was worth the risk. Aside from the human issues surrounding Alzheimer's, it was strictly a financial decision. And if the drug is successful or not, the decision to recommend selling the shares will be made for financial decisions only.
You Must Separate Emotion From Reality
That said, I'll be terribly disappointed if the drug is a dud. Not only for my subscribers, but also for millions of Alzheimer's patients and their families. The disease runs in my family, so it's especially personal.
However, I won't let those emotions get in the way of taking a profit or cutting a loss. If it doesn't work I'm not going to hang on to hope, looking for some morsel of data that justifies holding onto the stock. The bottom line is that if the drug isn't proven to be safe and effective, I don't want to own the stock anymore.
Biotech investors often tell me that they can't/won't sell a stock because they've become emotionally invested, as well as financially. This isn't surprising -dreams of riches and a better world are wrapped up in these tiny companies.
But you simply cannot allow that to happen, otherwise you risk taking a double hit if things don't pan out in your favor.
So how can you remove emotion from the equation if you're not using a stop? Fight emotion with emotion.
Three Ways to Take the Emotions Out of Your Investment Decisions
#1: Write Down Your Reasons:
When you buy a stock, write down the reasons why you'd sell and post it somewhere near your computer. Perhaps it's when the stock hits a certain price, or when news on a particular drug comes out.
Whatever the reason is, write it down on paper and stick it in a visible place. That way, when your catalyst hits, it will be tougher for you to justify to yourself why you're going against your original idea.
#2: Phone a Friend:
This doesn't just work for "Who Wants to Be a Millionaire." Telling a friend or family member your reasons for selling a stock is even better than writing the reasons down for yourself.
After all, you'll face some serious peer pressure if you suddenly change your mind and refuse to take profits or cut a loss. Outsiders aren't as emotionally involved as you because it's not their money on the line, so they should be able to make you see that your original reasons are still right.
#3: Conduct an Annual Portfolio Review:
Review your portfolio at least once a year. Take a look at every stock and ask yourself why you're still holding it. If your answer sounds more like a justification than a legitimate reason, dump it.
Any time there is money involved, emotions run high. Of course, it's easier to get less attached to stocks in other sectors. For example, many investors have no problem letting industrial stocks go when their trailing stops are triggered.
But it's your job to remove as much of it as you can and focus on decisions that will benefit your portfolio.