recalculating: why we are hardwired to fail financially and how to overcome it
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Emotional Mistakes When
Choosing an Investment
BUYING BECAUSE EVERYTHING IS “ON SALE”
You only make an investment when the company passes all of your tripod tests. You don’t buy simply because a stock is down 10% today and “looks cheap”. Any time you use words such as “I feel like” or “it looks like” you are letting emotion make your investment decisions. When the tripod tests are passed then you make an investment.
FALLING IN LOVE WITH A STOCK
Just because one of your stocks has increased substantially you still need to sell it when it fails your tripod tests. Past performance does not exempt your stocks from tripod testing. If you were building a track team you wouldn’t add a runner that set the record 10 years ago. You want current competitors. Enjoy your gain, take it, and replace it with a current performer.
You have a stock in your portfolio that has been a strong performer and has now passed all of your tripod tests except 1 key test. Say for example current ratio. You then start to rationalize why that happened and decide to make an exception for this stock. Exceptions can lead to losses because you are now accepting a stock that has not passed all your tests. Many times I have seen very successful portfolio managers fall prey to losses when they make exceptions. Be disciplined and follow your analysis..
Occasionally we can end up with market situations where your tripod process ends up generating a list of stocks that are all from the same sector. You want to make sure that you don’t overweight anyone sector in your portfolio. Create a rule that you will follow, for example limit your exposure to no more than 20% in any one sector. In a 30 stock portfolio that means you would not have more than 6 holdings or 20% in any one sector.
We talk about the X factor or what I called Breakevenitis in Chapter 8 of Recalculating. This is when you buy shares at a certain price and the share value has decreased significantly from where you bought at. A stock has dropped from say $40 to $25 and you don’t want to sell until it hits $40 again. However what you should be considering is that you have $25 right now and, forgetting how you ended up with $25, where would you invest it today. Would it be in your current stock that maybe no longer passes your tripod test? Or would it be in a new stock that passes your tripod test and has better potential for upside? Forget the past, forget how you got to your current position, and invest the dollars you have available today into the best prospects for growth.
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