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With Valentine's Day right around the corner, love is in the air. It's a time for new couples to bask in their newfound bliss and for those who've been together awhile longer to rekindle their feelings for each other. If you're among the single, it's a time either to seek out someone to share the holiday with or to celebrate your independence with a candlelight dinner for one.
When it comes to their portfolios, most investors have a love-hate relationship with the investments they choose. In most portfolios, you can see a lot of similarities with romantic relationships. Many investors have particular holdings in tried-and-true companies they have held since they first started investing. On the other hand, no matter how dedicated you may be to the strategy of buying and holding stocks for the long term, you'll usually find at least a few companies that have offered short-term trading opportunities that were too good to pass up. In some cases, those opportunities may come up repeatedly, and you might find yourself having the stock-market equivalent of an affair with those shares, buying and selling them every few months or years when the time seems right. When your portfolio treats you well, it's easy to love your investments. But when the tide turns, watch out; hell hath no fury like an investor scorned.
Getting in too deep
Investing (like love) can be an emotional roller coaster. One moment, all your stocks are rocketing upward and you're on top of the world. In the blink of an eye, however, everything can turn around, and you're suddenly ready to sell everything you own and give up on investing entirely.
Mastering your emotions is essential to successful investing. If you only pay attention to your emotions, then the decisions you make not only won't have a rational basis behind them, they're also more likely to be exactly the wrong thing to do at that moment. As a simple example, everyone's familiar with the idea that the way to make money in the market is to buy low and sell high. That sounds simple, but think about how hard it is to do in practice. During a bull run like the one the stock market has been going through since last summer, it's likely that your stocks are giving you exceptional returns. The last thing you're probably thinking about right now is selling; why would you want to sell when all you have to do is keep your investments untouched and let the money keep rolling in? Even if you've successfully taken profits off the table in the past, the strongest memory you may have is of the stocks you decided to sell continuing to rise, meaning that you missed out on extra profits.
Conversely, buying when the market is falling takes a lot of courage. Even though prices are cheap, you're never sure whether stocks have hit bottom or whether the stocks you buy will continue to fall. With the stocks you already own, it's hard to see your account's value falling steadily over days, weeks, and months of market declines; the emotional pressure to sell and stop any further pain can become nearly irresistible over time.
Rationally, history shows the results of giving into these common emotional reactions. While not taking profits at the top may not be the worst thing for your portfolio, selling at the bottom is perhaps the most common mistake that investors make. If you find yourself wanting to sell if your stock's price falls, then what you're really doing is questioning your entire rationale for buying the stock in the first place. Because if you truly believed the stock was worth what you paid for it, then you should be even more excited if it gets cheaper for no apparent reason.
Loving a concept
It's easy to get emotionally involved in the business of a particular company. However, it's important to keep yourself from making investment decisions based solely on those emotions. You can find countless examples of this based on your own preferences. For instance, just because you think that Mac computers are the best thing since sliced bread doesn't necessarily mean that Apple stock is going to perform better than IBM. You might think Pepsi is the worst drink on the planet but still prefer it to Coca-Cola as an investment. There's absolutely nothing wrong with that; in fact, if you refuse to make a rational investment decision because of an emotional bias, then that might be a big problem.
One of the biggest mistakes investors can make is to think that a great idea has to produce financial success. You only have to look at the most recommended post in Fool history to see the dangers of falling in love with a business; that particular investor lost everything he had, and then some, by counting too much on the prospects of Celera (NYSE: CRA). Even though it may seem unfair, good concepts don't always produce riches for the people who come up with them.
As you celebrate Valentine's Day in whatever way you choose, be happy and enjoy the romantic atmosphere. But when it comes to investing, leave the mushy stuff at home. Your portfolio will be glad you did.
By Dan Caplinger
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