Imagine you just bought a new TV. You take it home and excitedly unbox it and set it up.
But a couple days later, the thrill of the purchase is gone and the doubting begins. “Should I have gotten the 44 inch instead of the 42 inch?” you ask yourself. “Should I have waited until 6D comes out next year?”
And then the worst question of all: “Was buying this a mistake?”
Whether it’s buying a TV, a house or an ocean cruise, spending a lot of money triggers a range of emotions. Controlling these emotions – known as “buyer’s remorse” – can mean the difference between a good investment, and one that you’ll both regret and lose money on.
It’s the same sort of thing with buying shares. “Was my timing right?” “Did I just buy a lemon of a stock?” “Is the market about to collapse?” And the underlying question is, “What if I lose money?”
Another problem is to immediately justify the purchase
This is called “post-purchase rationalisation.” We focus on the strengths of what we bought, and overlook its faults. We might also dwell on the weaknesses of the alternatives.
This also happens when you buy a thing – or a stock – and then see a few weeks later that it’s cheaper. Had you waited a few weeks you could have bought the same TV, or stock, for less. Then your brain will try to convince you that you needed to make the purchase at the higher price. (After all, you did need the new TV for the big match.)
With practice, we can convince ourselves that any purchase was the “right” one – no matter how flawed it really was. Post-purchase rationalisation – also known as “buyer’s Stockholm Syndrome” can lead to bad buying decisions in the future.
Stockholm Syndrome is the psychological condition when hostages feel sympathy for and attachment towards their kidnappers. In this case, the customer (the “hostage”) is held captive by the product he buys (the “kidnapper”’). And the buyer eventually convinces himself that he likes the product.
How buyer’s remorse can lose you money
Beating yourself up after buying something isn’t going to change the fact that you made the purchase. And it may lead to an impulsive decision to return (or sell) a product (or stock) that was in fact a well-reasoned and smart idea in the first place.
Second-guessing yourself to justify a trade that isn’t working out can be just as damaging. This can lead to refusing to accept that you’ve made a mistake, and prevent you from learning a valuable lesson from the investment.
It might also stand in the way of following through on your stop-loss. Selling a losing stock is an acknowledgement of error. But if you’re too caught up in explaining to yourself why it was actually a good idea, you might violate the most important rule of investing: Don’t lose money.
In fact, ownership leads to emotional attachment. We place a higher value on the things that belong to us – whether it’s a house, a car, a dog or a stock. This also makes taking a loss on an investment an emotional challenge. That’s why a psychopath’s no-emotion psychology is ideal for investors.
There are ways to prevent buyer’s remorse and post-purchase rationalisation from affecting your investment decisions:
– Recognise your mistakes. In other words, know how to take a loss and make sure that you learn from the outcome. Examine exactly why a certain position lost you money, rather than trying to convince yourself that you were right all along, and that “the market” was wrong. (The market is never wrong: The investor who loses money based on the idea that he knows more than the market is wrong.)
– Avoid impulse buying and selling. Researching a stock before investing will help to reduce buyer’s remorse, as you’ll later be better able to explain to yourself why you made the decision. You’ll also feel less need to rationalise the purchase. Selling based on a gut feeling that you were wrong in the first place is just as bad.
– Follow your own discipline. Recognising a bad trade in time might prevent a mildly negative position from turning into a monumental loss. If you hit your stop-loss, sell.
As with any investment pitfall that we’ve discussed, taking emotion out of the investment process is a critical ingredient for making money. Be objective, and don’t let your feelings cloud your judgement.