It’s Harder Than You Think: The Pitfalls of Emotional Investing

There has been plenty of frenzy about missed opportunities in investing lately. If you bought $100 worth of Bitcoin in 2010 and held it until today, you’d have about $60 million. If you bought $1,000 worth of Dogecoin on January 1st of this year and held it until today, you’d have about $33,000. Massive returns beyond the more riskless 10–13% S&P average annual return are seemingly more commonplace than ever before.

These types of articles and sound bites fail to accurately describe the key difficulty in being a good investor: you have to hold. Buying stocks and cryptocurrencies has never been easier thanks to platforms like Robinhood and Coinbase democratizing access to financial instruments and lowering the overall cost of investing. With how markets are trending over the past year, anyone could have taken that $100 and generated a positive return, but the size of that return (again, thanks to market trends) would have largely been tied to that individual’s ability to hold.

Diamond Hands are the key to generating outsized returns

Think about the holds required for the outsized returns in venture capital, for example. Investors in Coinbase’s series A paid 20 cents per share for a 5 million valuation. Today the stock is worth 342, and investors are realizing over a 4,000% return. There are always opportunities for early investors to liquidate during subsequent financing rounds, but there is a reason most don’t employ a short-term strategy: it doesn’t work for their risk profile.

There’s a reason that the best investors are dead people: the human psyche is not designed to invest intelligently over a long period of time. We overvalue the short-term value of our decisions and largely fail to consider their long-term implications. Despite the fact that the stock market has a positive momentum trend since its origin, the average investment holding period from 1992 to 2012 was six months. This type of investment strategy returned over 3% less than those that held through the ups and downs (and that’s without accounting for short-term capital gains tax, which would have eaten up profits even more).

Despite multiple down cycles, markets have been in a positive trend for over a century

This isn’t to say that you should hold onto positions solely because you are taking a longer term perspective; buyers of Bitcoin when it first hit $20K would have seen 70% losses before the stock returned to their initial point, and there were plenty of times on the way down that holders could have sold out with their eyes toward a better initial entry. Entry point is important, as is dodging losses that can potentially limit your total upside. That’s the hard part.

The Hard Part

So why don’t people hold, even when all of the data points to its benefits? Why can’t people get out of their own way? Hubris has been the downfall of many, from retail investors to hedge fund billionaires. Taking on too much risk can attach an emotional element to one’s trading, especially if one’s positions are the result of the exciting returns they are reading about and they are frustratingly struggling to become millionaires themselves.

Managing this cycle and understanding where a stock is at in this process is important to making the right decisions.

If you check your portfolio once a year, you would find that it’s positive 93% of the time. If you check it once a quarter, however, the number drops to 77%, and daily is a dismal 54%. When considering the fact that humans feel twice as much pain taking a 1% loss than they do a 1% gain, you can start to see why so many people buy at highs and sell at lows.

It’s easy to wish that you had invested in Amazon or Bitcoin years ago and believe that you would have held it until today, but for most people this just isn’t realistic. Think about how many times you would have said no to selling a position that was returning 1,000% or more. Depending on the frequency of one’s trading, that number could become astronomical over a 20 year investment. The biggest wins end up being the product of intentional and disciplined holding (or forgetting about an investment entirely).

Tips to become disciplined

• Be excited when you see red; be cautious when you see green
• Zoom out. Making a long-term decision to sell based on how a position has moved in the short term is dangerous. Take longer term views in your stocks, and analyze them on a frequency appropriate to that time frame.
• Be intentional in your time frames; separate trades from investments
• Take emotion out of the equation. Stop looking at where positions go after you sell them and stop looking at stocks after they’ve already taken off.
• Treat wins like receipts, not as opportunities to make more money.
• Don’t chase.