Wednesday, August 10, 2011

MarketPsych Alert: Investors at Risk for Classic Investing Mistake

(First off- it you haven't read THIS , we invite you to do so. For one thing, it is so scarily accurate that you will not only want to subscribe to Dr. Peterson's Data Service, you will want to rent him out for parties. For another, it contains wisdom and stick-your-neck out prognostications for what to look for next.)


Would you rather have flowers in your garden or a bunch of gnarly weeds?
Obvious answer, right?

Not so when it comes to investing. And at "crisis points" like this one (markets down another today and fear is getting higher than Timothy Leary at a Grateful Dead concert ), it puts investors at risk for one of the biggest investing mistakes.

When the market is as scary as it is right now, there's always a temptation to sell. Perhaps to avoid further losses, or maybe just to have more cash available to go bottom fishing when the dust settles.

(MarketPsych Note: The above sentence has just been voted the single worst mixed metaphor in MarketPsych Blog history.)

Awkward phraseology notwithstanding, at times like this many investors will look to liquidate some stocks to free up cash.

The temptation will be to sell the stocks in which you have the biggest gains. Here's the problem.

The stocks that have performed well have done so, because they are BETTER stocks. There may be exceptions, but stocks that go up are by DEFINITION better stocks than those that don't.

Here's MarketPsych's internationlly famous "Wicked Gardener" Analogy.

Your portfolio is a garden. Good stocks are blooming flowers. Bad stocks are weeds.

Many investors free up cash at times like this by clipping those beautiful flowers and holding - or in some cases watering (i.e. buying more of) -- those weeds.

By doing so investors systematically clear out their quality holdings, ensuring that what remains in the portfolio are lower quality, worse run, worse performing companies.

Be aware of not only of this temptation, but also the underlying motivation. When looking at positions to sell, ask yourself this; are you chosing the stock because it is the one you should going forward? Or are you really selling a stock because it hurts less than realizing a loss on a position? And be 100% honest.

Because if it's the former - good for you. If it's the latter, well, we can relate, but protecting your feelings comes at the cost of protecting your money. It's a recipe for long term investing failure.

So I'll make a deal with you:

You do what's right with your money.

I'll work on my metaphors.

And hey... let's be careful out there.

-Dr. Frankenstocks

Frank Murtha, Ph.D.

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