Do you have a case of “get-evenitis”?

Sep. 09, 2010 10:23 AM ETSPY, IWM1 Comment
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While not a terribly sophisticated term, get-evenitis refers to the tendency of individuals to NOT cut losses short, and instead hold on to losing investments until they can be sold at the break-even price paid for it. This happens because realizing a loss is painful, while its easy to feel good about selling something at a gain. As a result, investors tend to sell winners too soon, and hold onto losers for too long.

The main psychological effect at work in these cases is something known as “loss aversion.” This phenomenon was studied at length by Daniel Kahneman and Amos Tversky in their work on prospect theory. In essence, they discovered that people dislike a dollar loss roughly two times more than they like a dollar gain. As a result, humans are more likely to avoid taking a loss from where something was bought, selling paper gains instead of paper losses.

The implications of this can be quite significant over the long-run. A study by Terrance Odean in 1998 studied customer accounts at national brokerage houses. He discovered that a stock that was at a gain from where it was bought was 70% more likely to be sold than a stock which was below its purchase price. Furthermore, the gains made were not necessarily large. In other words, people cut their GAINS short, and left their losses to get bigger and bigger, hoping for a comeback.

This can be quite detrimental to long-run returns. First, there are tax advantages to taking losses, and tax disadvantages for capital gains. When you sell at a loss, you get a tax rebate. When selling at a gain, your gain is taxed. On top of that, it turns out that if those individuals in Odean’s study actually held onto their winning investments just one year longer, those investments would have outperformed the market by a little over 2%, as opposed to holding onto the losers for another year which would have on average underperformed the market by roughly 1%.

The Take-Away
Be true to yourself, and know what the research shows. Instead of wanting to sell an investment at a gain or holding an investment at a loss, don’t use the price you paid for the investment as your reference point. Instead, always ask yourself whether there is a better opportunity and don’t let hope of getting back to break-even affect your ability to better put your money to work elsewhere.

Please Note: This article expresses the views of the author and such views are subject to change without notice. Pension Partners LLC has no duty or obligation to update the information contained herein. Further, Pension Partners LLC makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. This article is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Pension Partners LLC believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This article, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Pension Partners LLC.

Disclosure: The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing.

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