Although previously released by Johnny Cash to little fanfare, in 1978 the recently passed and greatly mourned Kenny Rogers covered “The Gambler” and it became one of his greatest hits.
The most enduring and oft-recited lyrics are, “You've got to know when to hold 'em, know when to fold 'em”.
So, what does a country single have to do with better understanding investing? It certainly isn’t about being a gambler, although understanding risk and the chances one takes is a key aspect of investing especially in these volatile times.
Rather, that key lyric is indicative of how human behaviour changes when an investor is making an acquisition of a security or selling out of a position.
Think of it this way. Say you have a “play money” account at a discount brokerage. You have been quite successful investing in Apple stock over the years, and are now deciding whether to take your profits before they decline even further, or continue with the investment for hopefully greater gains when the market recovers. Listening to your ruminations and giving no feedback, is your trusty rescue dog Versace (a high-end name for a humble beginning) curled up at your feet following a late-day walk.
Unable to make a decision, you opt for something to quench your thirst and postpone any action for a few minutes. Upon your return, you realize that Versace has taken one of his meaty paws and slapped your computer keyboard – and by doing so, somehow miraculously sold your entire Apple stock position.
So now you are confronted with a completely different decision: do you leave the stock as sold and take your profits, letting your dog make your investment decisions for you? Or do you buy back the stock and continue to hold it until you have attained conviction in your investment decision?
In other words, do you hold 'em, or fold 'em?
There is no right or wrong answer to this dilemma. However, most people choose as Jack Nicholson’s character J.J. Gittes, was forcibly told in the film Chinatown, to “let sleeping dogs lie” and take no further action.
The reason: people tend to be more passionate about, interested in and care about things they own than things they don’t. Behavioural scientists refer to this as the Endowment Effect. The same principle extends to other life decisions, such as buying a house versus selling your own home, key relationship inflection points, or even what to do with a well worn baseball glove past its prime.
For investors, this force is compounded by another bias known as Loss Aversion, where people would rather avoid losing a dollar than take the opportunity to gain a dollar. People are loss averse whether the information available supports that action or not.
The endowment effect and loss aversion are just two examples of many biases that have been identified, which illustrate how human behavior can affect otherwise sound and objective investment decisions.
This is a force not limited to the amateur investor. Professional portfolio managers in charge of actively managed mutual funds and institutional pools are acutely objective when purchasing a security; but become remarkably subjective when it comes time to decide whether they should hold or sell that same stock.
Whether you are an individual investor, work with an investment advisor or follow the strategy of a portfolio manager, each individual involved in the decision chain can be affected by these biases.
It is important to understand these forces and the potential they have to increase or decrease your investment and overall net worth.
For as the song says, “You never count your money when you're sittin' at the table”.