Best Investing Tip for 2013
Staying nimble and open to change is a key to your entrepreneurial success. You know it’s crucial to periodically recrunch your numbers--and your assumptions--and adapt your business plan accordingly. But when it comes to managing your personal finances, my experience is that you’re a lot less apt to give your investment portfolio a clear-eyed checkup from time to time.
Chances are you’re being done in by your own self-imposed "anchors."
That’s the behavioral finance term for becoming attached to a dollar value that then becomes the reference point for all decisions for that investment.
An all-too-common anchor is the costly Breakeven Gambit. When the value of an investment falls below what you paid, you tell yourself, I just want to break even, and then I will sell. That’s your brain doing some serious messing with your financial success.
Your anchor price is a completely arbitrary number in your head (or your financial statement). It has no bearing on the future trajectory of that asset. Sure, you can want and hope you get back to breakeven, but hope is not a winning investment strategy. Instead of being anchored to your acquisition cost, you should be doing a complete recrunch of your assumptions for the investment. If you think there is still a strong fundamental case for its value to rise going forward, then sitting tight is smart. But if there’s no external catalyst--as in external to your own internal anchor price--that’s a strong sell signal.
Becoming anchored to the upside can also thwart your long-term success. An investment that has done so spectacularly gets the hall of fame treatment: You vote it into some hallowed place because of its (and your) past success. But what about its future?
Every investment--be it a current loser or winner--has an implicit opportunity cost. Is there a fundamental reason for a losing investment to rebound, or would you be better off selling it today and reinvesting in another investment with better prospects? The same question needs to be asked of every winning investment; I’ve never seen sentimentality work as an investment strategy. If you can’t make a clear case for why a profitable investment will continue to be profitable, you should be asking yourself if it’s time to cash in and reallocate.
If your investments are confined to tax-deferred vehicles such as 401(k)s and IRAs, there’s no excuse for not putting your portfolios through a clear-eyed reevaluation. There is no tax bill when you make trades within these retirement accounts.
Losses can offset gains
For other investments, remember that all investment losses can be used to offset investment gains. In years when you don’t have realized gains, you can claim up to $3,000 in investment losses to offset ordinary income. If your loss is more than $3,000, it can be carried over to offset capital gains or ordinary income in subsequent years.
Once you lift a few costly anchors in your portfolio, you’ll need to decide where to reinvest that money. Keep an eye out for your recency bias. That’s another important behavioral tic that compels many investors to base their decisions on what is most visceral and front of mind.
The impact of the financial crisis has triggered a lengthy bout of recency bias against stocks. Since 2008, for every $1 invested in stock mutual funds and exchange-traded funds, or ETFs, more than $30 has flowed into bond funds and ETFs. But becoming too dependent on bonds is going to make it especially tough to meet your long-term investment goals.
PRINT THIS ARTICLE