One of the more common behavioral mistakes we make when it comes to investment decisions is the tendency to anchor to a certain value or price. When we focus on, or anchor to, a price, it can lead to costly blunders. Here are a few examples:
1. Imagine you bought your home at the height of the housing boom. You paid $800,000, and a few years later you needed to sell it. We have a tendency to feel like we should at least be able to get what we paid for it. So you insisted upon listing it for $800,000, even though the market value is less than that. You passed on offers around $775,000 and then rode the market all the way down to the point where you hoped to get $650,000 a year later. Now that first offer looks like a dream.
The reality is that the market doesn't care what you paid for your house. It doesn't care how much you put into it or what it cost you to landscape. All that matters is what it's worth today.
2. You buy a stock for $50 a share, and six months later it's $30. You decide that you really shouldn't own it anymore but you want to wait until you "get back to even" before you sell. This idea of holding on to an investment that is no longer appropriate, or may have been a mistake in the first place, until you get back to even makes no sense. The fact that you paid $50 has no bearing whatsoever on what you should do now.
Source: BehaviorGap.com.
In fact, I think it is fair to say that getting back to even is never a good reason to hold on to an investment. If you find yourself saying that, it's time to reevaluate.
3. Your portfolio was worth $500,000 at the top of the tech bubble in early 2000, and you still think about that value each time you open your statement and see that it's worth less than that. You just want to get back to your high-water mark of $500,000.
This may not have any impact on your decisions, but it sure is affecting your life. I know people like this, still holding on to a value in the past. It is like that guy next door who is still telling stories of his glory days in high school football.
The past is the past. All that matters now is making the correct decision for today.
A version of this post appeared previously at The New York Times.
Carl Richards is a financial planner and the director of investor education for the BAM ALLIANCE, a community of more than 130 independent wealth management firms throughout the United States. Visit Behavior Gap for more of Carl's sketches and writings.
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