While two recent articles (this and this) focused on some reasons not to sell a stock, this article lists a few lies we investors tell ourselves to hold onto some stocks. We hope you'll take away a few valuable lessons from this. After all, being brutally honest with yourself is one of the most critical requirements to be a successful investor.
I'm A Long-Term Investor...Oh Wait, I'm A Trader: There is absolutely nothing wrong with being a long-term investor. What is wrong is switching back and forth just to suit the current situation. Many investors get into momentum/speculative stocks like Green Mountain Coffee Roaster (NASDAQ:GMCR) and Netflix (NASDAQ:NFLX) for a quick buck. But when those positions lose money, their stance changes to, "I am in it for the long term". This is just hoping things turn around without conviction. You will be better off selling such positions and owning up to your mistakes. If you don't reach your stock-specific goal, get out of the position.
This Time It's Different: Most long-term investors are familiar with this phrase, especially during bubbles. Bubbles have a few common features, like new market leaders, discussions of concepts over familiar factors like earnings and dividends, and a sudden jump in interest in a particular sector.
Be it the Nifty Fifty bubble of the 1970s or the tech bubble of the late '90s and early 2000s, investors continuously ignored all warning signs and assumed things were different that time. Everyone knows how things ended.
Had the Facebook (NASDAQ:FB) IPO taken off as most expected, we could have very well seen a social media bubble, but the lukewarm reception to FB has made sure other social media stocks do not run amok, either. Justice can be delayed, but not denied. To put that in the stock market context, fundamentals will eventually matter. It is always a question of when, not if, bubble stocks will crash.
If It's So Bad, Others Won't Be Buying: This is a common excuse given by investors who follow the herd and are too lazy/afraid to do their own work. During the Enron episode, a large group of investors, including the so-called experts, turned a blind eye to all the obvious problems right in front of them. It might seem like hindsight bias talking about Enron after so many years, but the point is, take your time and put in your own efforts. Do not go just by analyst opinions, estimates, and upgrades.
I Am A Young Investor, I Can Afford To Take Risks: No one likes to lose money. No matter if they're young or old; tall or short; rich or poor, no one gets into the stock market to lose money, period. This is another excuse investors frequently use when their risky/growth plays go down.
While retirees may not have the same cash flow as a young investor in his/her twenties, they certainly do have much more capital at their disposal than the youngster who is working at his/her first job. It's loosely like the free cash flow vs. cash on hand scenario we have in stocks. The point is, just because you're young does not mean you need to take imprudent risks.
The common statement, "If you are young, you can survive dips" might broadly apply to the market, but not to individual stocks. There have been tons of stocks that "dipped" and never came back to their original levels. The Radio Corporation of America (RCA) of the 1920s and 1930s never came back. Honestly, barring some miracle, do you see Research In Motion (RIMM) coming back from the brink ? Very low odds. (Mergers and takeovers apart).
I'm Diversified, So I'm Safe: This statement may irk some investors, as this is not a lie, but more of a misconception. While diversification has its own merits, it is by no means the be-all, end-all of investing. If it was so simple, indexing would yield would fantastic results each year, as the S&P and Dow Jones Industrial Average are diversified enough.
You still have the systematic risk that you cannot diversify away. As this chart shows, there's always a limit to how much you can diversify your risks away. Beyond that, it's all random.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.