UNHEALTHY ATTACHMENTS

Have you ever made yourself suffer through a bad movie because, having paid the ticket, you felt you had to get your money's worth? Some people treat investment the same way.

Behavioral economists have a name for this tendency to stick with a losing strategy.  It's called the "sunk cost fallacy".

Let's say a couple buy a property next to a freeway, believing tha planting trees and double-glazing will block out the noise.  Thousands of dollars later the place is still unlivable,  but they won't sell because "that would be a waste of money".  This is an example of a sunk cost. You are reluctant to cut your losses and sell that would be an admission of defeat.

It works like this in the equity market.  When forecasts don't come to pass, they hold on regardless.

The motivations behind the sunk cost fallacy are understandable.  But there are ways of dealing with this challenge.  Here are seven simple rules:

1. Accept that not every investment will be a winner.  Stocks rise and fall based on news and on the markets' collective view of their prospects.  That there is risk around outcomes is why there is the prospect of return.
2. While risk and return are related, not every risk is worth taking.
3. Diversification can help wash away these individual influences.  Over time, we know there is a capital market rate of return.  But it is not divided equally among stocks or uniformly across time.  So spread your risk.
4. Understand how markets work.  If you hear about the great prospects for a particular company or sector, the chances are the markets already knows that and has priced the security accordingly.
5. Look to the future, not to the past.  Investment is about what happens next.
6. Don't fall in love with your investments.  People often go wrong by sinking emotional capital into a losing stock that they just can't let go.  It is easier to maintain discipline if you maintain a little distance from your portfolio.
7. Rebalance regularly.  This is another way of staying disciplined. 

These are simple rules.  But they are all practical ways to take your ego out of the investment process and avoiding the "sunk cost fallacy".

This approach may not be as interesting.  But by keeping an emotional distance between yourself and your portfolio, you can avoid some unhealthy attachments.

Diversification does not eliminate the risk of market loss.  There is no guarantee investing strategies will be successful.