How the Normal Investor Thinks

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How the Normal Investor Thinks

Let's examine how the normal investor thinks and makes decisions. If you are a typical investor, you probably keep records of your transactions in the market, perhaps in the following manner:

When you think about selling a stock, you likely look at your records to see what price you paid for the stock, don't you? If you have a profit, you may sell; if you have a loss, you will wait rather than take the loss. After all, you didn't invest in the market to lose money.

So, in this example, you may decide to sell your Luby's Cafeterias or Wal-Mart Stores stock because they show a profit. But these are the stocks you should consider keeping. Instead, you should probably sell one of the stocks showing a loss, like Navistar or Storage Technology.

If you're the type of person who would have been inclined to sell Luby's, the entire basis of your sell decision is unwise, resulting from the "price-paid bias" which 95% of investors have.

Suppose you paid $30 for a stock two years ago. Today it is $34. You may sell it because you've made a profit. But what does the price you paid for that stock two years ago have to do with its worth today—or whether it should be held or sold now?

Suppose you paid $40 for the same stock six months earlier and, therefore, have a loss today. Does this change its future potential? Probably not! What you paid for a stock years ago or whether you have a profit or loss may have little to do with future potential.