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Should You Turn Your Short Term Speculation Into Long Term Investments?

I have been in several conversations when someone, let’s call him Wong, tells me that he has invested in a company because of a hot tip. “The share is sure to double in a few weeks’ time!” he tells me. Then he will go on to explain how he plans to make a quick profit and sell once he makes a modest 50% gain.

Months passes, the price of the share has not gone up, but down. Wong will now say that the company is now a good long term investment and he is planning to hold it for the “long term”.

The story of Wong is rather typical. I have come across many “Wongs” in my investing career and I was once a “Wong” too. The reason why we are demonstrate this kind of behavior is because of a psychological bias called loss aversion.

Loss aversion is an emotional bias where we fear losses more than we care about making gains.Therefore, we feel that if we do not sell those shares, the losses are not realised and thus we can trick ourselves into thinking the losses are not really there. We would then rationalise our decision by changing our investment reasoning, by changing a short term speculation into a long term investment.

There are a few problems with this bias. Over time, we might end up holding all our losers and selling our winners. In that way, our whole portfolio might consist of “losers”. By keeping our cash in these losers, we are missing out on the opportunity to reinvest that portion of our wealth into other better investments. In the long run, our investment would not be profitable at all. My colleague wrote an article on this recently.

How can we prevent this bias?

The first thing to do is to understand that such a bias exists and that it is part of human nature. Once we acknowledge this, it is easier for us to identify it when we see ourselves falling into the bias.

Secondly, we always need to be sure of why we are making an individual investment. For example, we might invest in Global Logistic Properties Ltd (SGX: MC0) because we like the growth potential of the logistic sector. One day GLP might decides to go into the Hotel business because of slowing growth in the logistic sector. Regardless of whether we are making money at that point in time with that investment, we might need to strongly consider to sell that investment as the direction of the company has diverted from the initial reason of why we invested in it.

This example holds true to the story of Wong. Similarly, one should not change into a long term investment just because one is not not willing to realise the losses. Wong should have considered if that particular investment would make sense for a long term, and make adjustments accordingly.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim does not own any companies mentioned