Why we can't let go of loser investments
A trader holds his head while working on the floor at the New York Stock Exchange.
Tess Vigeland: So we've just addressed the idea of shedding your bank. Now let's talk about shedding all those loser investments in your portfolio. Turns out it's a very, very difficult thing for us to do; our brains are hardwired to resist.
Jason Zweig wrote about this ina recent column in the Wall Street Journal. Welcome back.
Jason Zweig: Great to be with you Tess.
Vigeland: Now I have to say, for the most part on this program, we talk to people about keeping their investments very simple, preferably in stock market index funds. So what we're talking about here, when we talk about getting rid of losers, keeping winners, this is individual stocks, right?
Zweig: Most likely that's the situation people are in. Although I guess there could be cases where you have a loss on a diversified investment and you're struggling with the issue of whether to undersell it.
Vigeland: Well then, let's take the first line of your article, where you say, "Taking a loss is hard to take, but avoiding a loss can be even worse." What does that mean?
Zweig: Well, there certainly can be a tax benefit to people when they sell an investment for less than they paid for it, because you're allowed to write-off your loss against your ordinary income. So a loss that you have on an investment, you can turn it into an asset.
Vigeland: Then why is it that people have been avoiding doing that? Is this a matter of being ever-hopeful that stock is going to come back?
Zweig: Yeah. I mean, the way I like to think of it, Tess, if you buy a stock or a fund, let's say you paid $50 for it and now it's at $10. If you bail out now, you abandon all hope it's ever going to get back to what you paid for. Plus, you have to admit you made a mistake. But if you keep it, you can always tell important people in your life -- particularly, yourself -- you're not wrong, you just haven't been proven right yet.
Vigeland: We like to fool ourselves, right?
Zweig: Hope springs eternal, especially in the human mind when we're making financial decisions.
Vigeland: Talk to us about what's wrong with that? You mentioned some research done at Emory University.
Zweig: Yeah, there's a wonderful recent study that I got to see some of the results of. They had people lie inside a brain scanner, while they were making decisions about whether to hold or sell an investment. And they found something that's quite surprising. This reward center of the brain did not have a significant response when the investment went up in price, below the level people bought it. So you paid $50, it's at $10, it goes to $10.25 -- and you don't seem to getting an internal reward signal in your brain. It's as if you automatically expect it to go up. So when it does, it doesn't give you that thrill. And that may help explain why people hang onto losers.
Vigeland: But let's take the example, which I think is still fresh in a lot of people's minds, of March 2009, when stocks were at their lowest level in years, and a lot of people bailed. And within a year, the vast majority of them had recovered.
Zweig: Yeah. Well, I guess there's a couple things that I would point out. One is in a situation like that, you can realize the tax benefit without making a call on the market. I mean, let's just go back to our simple numbers in our example. You paid $50, it's gone to $10, and now it's March 2009, and you're looking at it and you've lost 80 percent of your money. You can sell the thing you paid $50 for at $10, you capture the tax benefit. But then you can take a second step. You can immediately buy a very similar but not identical investment. You maintain your exposure, but instead of just merely selling low, you're also selling low and simultaneously buying low. You haven't taken a view where the market is going in the future, but by buying something substantially similar, I'll maintain my exposure and if the market does go up from here, then I'm still in it.
Vigeland: Jason Zweig writes the Intelligent Investor column for the Wall Street Journal and we'd love to bring him on to talk about our brains on investing. Jason, thanks so much for coming in.
Zweig: Great to be with you Tess. Thanks.