A client recently called me to discuss the stocks in her IRA (Individual Retirement Account).
“I know an IRA account is a good place for growth stocks,” she told me, “since any taxes on the growth is deferred until I withdraw the funds. I chose the individual stocks in the account because I believe in the strong fundamentals of the company and that the company will grow. I am in this for the long term. But….my stocks are going strong and have surpassed my wildest dreams of growth. Should I sell now? If I sell now, I am guaranteed my profit, but I may lose out on future gains. If I continue to hold, I may get future gains, but then again I may lose current gains. What should I do?”
Here, the investor essentially answered her own question when she asked it. Logically, she should hold onto the stocks in her IRA for all the reasons she described. Yet, her fear of a potential future loss and her desire for an immediate gain caused her to question her strategy.
If she sells her strong stocks, she makes a common financial error known as the “disposition effect.” This is when you sell a winning stock instead of a loser. Investors erroneously think that selling a winner is better because they make a gain instead of locking in a loss. But dumping a losing stock might be better because there may be a real reason that the stock has gone down; perhaps it’s just not such a great company.
To prevent yourself from falling into the traps of emotional investing, ask yourself what is guiding you. Are you following your financial plan? Are your reasons for the initial purchase the same? Has your situation changed?
To prevent your emotions from pushing you towards financial disaster, stay steadfast in your plan and asset allocation model. If you need some logic to rein in your emotions and keep you safe from the disposition effect, speak with your financial advisor to find out more about mutual funds and money managers. (We got some great videos about them here.)
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published November 30, 2015.