Take a look from the two charts below.
Chart 1: Stock losing 80% of its value (Yellow: Dividend Reinvested; Blue: Share Price)
Chart 2: Stock gaining about 9000%, a 90-baggers (Yellow: Dividend Reinvested; Blue: Share Price)
Imagine yourself invested in the two companies above. One losing 80% of its value and one seeing a 9000% gain. Imagine the emotion running through you as you continue to monitor your investment throughout the whole.
Unfortunately, most of us are more likely to experience the first chart compared to the second chart. This is because of a bias called loss aversion. According to a definition of loss aversion;
“In prospect theory, loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains. Some studies suggest that losses are as much as twice as psychologically powerful as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman.”
This means that as we are more unwillingly to realize our losses than we are eager to realize our gains. Thus, if we follows our human nature, we would have long sold off our investment in chart 2 but hold on to our losing investment in chart 1 because we cannot bear the thought of realizing our losses. We can deceived ourselves but saying that paper losses are not really “Real” losses.
Yet, ironically, I have been deceiving all of you. As the charts are both showing the performance of the same company; Public Bank Berhad, a major bank listed in Malaysia.
The only difference is that chart 1 is showing the share performance during the Asian financial crisis from 1997 to 1998 while chart 2 is showing the performance of the share price since 1988 till today, the total return for the past 26 years.
I think the story highlights a few important points for us.
- Compounding can only works if we invest for a very long time, thus the real return only comes decades later.
- Every company, no matter how wonderful the business, will always face adverse condition in the stock market every now and then.
- If we truly invest for the long term, loss aversion is of lesser impact to us. However, the key here is to STAY invested for the long term.
Happy investing everyone.
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Stanley Lim’s personal capacity and do not in any way represent those of his employer and other related entities. Stanley Lim doesn’t own shares in any companies mentioned above.