How investors cope with losses
Rolling a losing position into a new stock can dull the pain of losing money
- Investors mistakenly tend to sell winning stocks in their portfolio and hang on to stocks on which they have made a loss. They do so in part to avoid the pain of losing money, but they can avoid the psychological pain of realizing a loss by selling a losing stock and immediately rolling the capital into a new investment, according to Cary D. Frydman and David H. Solomon at the University of Southern California and Chicago Booth’s Samuel Hartzmark.
- Investors who have rolled proceeds from an investment into a new asset tend to use the amount paid for the original investment as a reference point to compute gains and losses for the new asset, according to the researchers (see chart).
- Analyzing data from 56,546 individual investors’ accounts, the researchers find that investors who avoided the emotion of closing a mental account by selling a stock and reinvesting its proceeds made better selling decisions: the sold stocks earned 2 percent less over the next year compared with stocks that were sold but not reinvested.
- Institutional investors operate similarly, according to the researchers. They find that mutual funds experiencing inflows (and thus having the flexibility to roll into a new investment) were more likely to sell a losing stock. But funds experiencing outflows were less likely to do so, because the proceeds of a sale would have to be sent back to investors.