Avoid the Mistake My Dad Made…
My dad asked me for advice once.
He’d bought a condo in Myrtle Beach, South Carolina, several years back and was now wondering whether it was time to sell it and move on.
“Do you want to sell it?” I asked him.
“I’m really not sure. It’s complicated,” he replied.
“Do you want to buy it?” I continued.
“I already own it, Adam!” He must have thought I didn’t understand the question. But I did.
“I know! But imagine for a minute that you didn’t already own it,” I explained. “If you didn’t already own it today… would you want to buy it today?”
After a brief pause, my dad replied, “No! I wouldn’t buy it today!”
Without realizing it, my dad had fallen victim to a mental glitch that psychologists call the disposition effect: Our tendency to hold losing investments too long, hoping and praying to get back to breakeven and avoid a loss.
That’s the urge my dad was fighting when he was considering whether or not to sell his investment, which hadn’t exactly turned out as he had expected it to.
Long story short… he bought in 2006, expecting to merely flip the pre-construction contract. When that plan unraveled, he began renting out the unit, but couldn’t achieve positive cash flow. Eventually, he relabeled the would-be investment “The Family Beach House” and merely visited as often as he or our family members wanted.
After years of this, my dad wanted to sell and move on. But there was just one thing holding him back… the roughly 10% loss he would lock in if he sold.
I suspected as much, which is why I asked him that question – “Would you buy it today, if you didn’t already own it?”
You see, the following two decisions are economically identical:
- Choosing to stay in an investment you already own; and
- Choosing to buy an investment you don’t already own.
In both scenarios, you are an owner of that investment tomorrow.
But psychologically, there is a difference.
When considering a new investment, you don’t have to bother yourself with the psychological baggage of the investment’s past performance. You didn’t own it at the time… so who cares!?
But when considering whether to hold or sell an investment you already own… you have to face the psychological effects of how that investment performed for you. And in turn, you have to label yourself a “winner” or a “loser.” (And we all HATE being a loser, right!?)
So even though the money didn’t matter much to my dad, the psychological pain of adding one more tick mark to the “loss column” was almost too much for him to bear. He even admitted to me, “This deal didn’t go as planned, but I just wish I could get back to breakeven.”
That’s the essence of the disposition effect.
We feel a strong urge to hold unprofitable investments too long, simply because we can’t stand to admit defeat… and because the pain we feel when we lock in a loss is dramatically greater than the joy we feel when we lock in a win.
Psychologically, we walk away from losses – no matter how big or small – with a bruised ego, diminished self-worth, and a general lack of confidence in our investing prowess.
So we’re willing to try almost anything – mainly hope and prayer – to avoid locking in a loss.
It’s irrational. It’s not a good strategy. But investors routinely fall victim to the disposition effect (even without realizing it, most of the time).
How Do You Avoid Psychological Bruising?
I’m convinced that systematic (“rules-based”) investment strategies – like 10x Profits hold the cure.
Flipping the 10X Switch on and off frequently to play risk-on and risk-off positions means you can’t get married to any one position.
That’s why, when my 10x Switch says “sell”… you’ve got to sell!
For example, here’s what I sent to the readers already beta-testing 10X Profits for me, on the morning of May 17:
“Trouble Ahead” Signal Returns…
Buy VXX Today (Risk OFF)
May 17, 2017
With both the U.S. Sector and Global Markets spreads still dancing around their threshold levels, my model has flipped back into risk-off mode for now.
Well, the morning of May 17 is when volatility spiked due to the uncertainty surrounding Trump’s agenda. My beta testers had the chance to capture a quick 10.4% gain in just one day.
And then, the very next morning, my readers got this email from me:
As Crazy as it Sounds…Buy XIV Today (Risk ON)
May 18, 2017
Yes, I realize the VIX jumped almost 50% yesterday!
Yes, I realize the Dow fell more than 300 points.
Yes, I realize the Trump-Comey battle is gearing up to epic proportions!
Regardless of all this, my model has signaled another trade, based on yesterday’s closing prices. It’s telling us to switch back into risk-on mode… to buy into XIV once again.
My beta testers probably thought I was crazy, jumping back into the market right after a sudden spike in volatility.
But one thing I’ve learned over the years is to trust my systems…
Simply by flipping the 10X Switch between Risk ON and Risk OFF my 10X Profits system produced two trades in two weeks for a cumulative gain of over 25%!
That’s why, when it’s time to flip the switch, we flip it!