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When he began teaching behavioral finance at Claremont College, Amos Nadler decided he needed hands-on experience to discuss with his students. Until then, it had only a handful of mutual funds and ETFs.
“I needed some war stories. I needed to talk about wins and losses,” Nadler founder. The teacher of Wall Street and Ph.D. in behavioral finance and neuroeconomics, says CNBC Make It. “I have to put my money into playing and experiencing these things, and get them out of the lab, out of the textbooks.”
He added an action you’ve probably heard: Nvidiawhich was then trading in low figures. Nadler says it was worth between $800 and $1,000, but he sold much of it before 2014, when his shares turned what looked like a big profit at the time.
He opened his account with the intention of making some mistakes so that he and his students could learn. Only in retrospect did he realize the magnitude of that particular mistake.
As Nvidia stock has split several times since Nadler sold, his brokerage account now shows the original price he paid for the stock at about 48 cents. At the market close on December 11, Nvidia shares were valued at $139.31 each. This means that Nadler lost more than 28,000% of his profit.
“That amount of money is enough to buy a nice house somewhere.” Nadler said in a discussion with behavioral finance expert George Dan.
Why did he sell it? Nadler says he fell prey to a toilet cognitive bias.
“The classic behavioral finance reason is risk aversion,” he says, which reflected his fear that his stock selection would soon fall to Earth.
“I bought Nvidia at low numbers, and now it’s gone up and I’m scared,” he remembers thinking. “I’m risk averse, and I’d rather go to the money because I can lose. I don’t want to gamble anymore.”
How to prevent cognitive biases from harming your portfolio
To understand risk aversion, ask yourself whether you would rather have $100 or flip a coin: $200 heads, $0 tails. What if the heads cost $300? Or $1,000? Where you fall on that spectrum can help a financial psychologist understand what level of risk you’re willing to take.
In general, everyone is afraid of the unknown to some extent. “A risk-averse individual prefers a safe bet to a risk,” says Nadler. What’s more, he says, investors tend to feel the pain of losses more viscerally than the joy of gains.
This can create fear around a winning bet in your wallet. A stock that has gone up can fall back and wipe out the gains, one might think. Better get the win now.
That’s what Nadler remembers, though. “What was going through my mind was, ‘Hey, I’m new to this. I’ve made significant gains in a very short time. I want to lock it up because I’m afraid it’s going to go down again.'”
Knowing when to sell your portfolio’s winners and when to let them run is a difficult decision for any investor, but it shouldn’t be an emotional one, Nadler says.
“It’s what’s going on in my head and, objectively, what’s going on in the world?” he says This often means acknowledging and charting your own feelings, and considering whether the reasons for making a particular investment are compelling, based on the underlying fundamentals.
If a stock goes up, for example, you may feel like selling for fear of a decline. But if the company still has a strong competitive advantage, a healthy balance sheet, and earnings that analysts expect will continue to rise, you may want to hold on.
“Let’s face reality and not let the emotional overlay of reality dictate our actions,” says Nadler. “Because it’s a good recipe for losing a lot of money.”
Or, you know, miss out on some pretty impressive gains.
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